Uniform Audit & Accounting Guide - maine.gov · Chapter 4 Cost Accounting ... Description of the...

UniformAudit & Accounting

GuideFor Audits of Transportation Consultants’

Indirect Cost Rates

Prepared by the American Association of StateHighway and Transportation Officials,

Audit SubcommitteeDecember 2001

American Association of State Highway and Transportation Officials444 North Capitol Street, NW, Suite 249, Washington, DC 20001, 202-624-5800

www.transportation.org

AASHTOUniform Audit & Accounting Guidefor Transportation ConsultantsDecember 2001 1/3/2002

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UniformAudit & Accounting Guide

For Audits of Transportation Consultants’ Indirect Cost Rates

Prepared by the American Association of StateHighway and Transportation Officials (AASHTO),

Audit SubcommitteeDecember 2001

Assistance and consultation provided by:

Southern Resource Center of the Federal HighwayAdministration (FHWA)

andAmerican Council of Engineering Companies (ACEC)

Transportation Committee

An electronic version of this guide can be found at theAASHTO home page: www.transportation.org

AASHTOUniform Audit & Accounting Guidefor Transportation ConsultantsDecember 2001 1/3/2002

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American Association of State Highway and Transportation OfficialsExecutive Committee, 2001–2002

President: E. Dean Carlson, Kansas

Vice President: Brad Mallory, Pennsylvania

Secretary/Treasurer: Larry King, Pennsylvania

AASHTO Executive Director: John C. Horsley, Washington, D.C.

Regional RepresentativesRegion I: William Ankner, Rhode Island

Joseph Boardman, New York

Region II: W. Lyndo Tippett, North CarolinaBruce Saltsman, Tennessee

Region III: J. Bryan Nicol, IndianaKirk Brown, Illinois

Region IV: Pete Rahn, New MexicoJoseph Perkins, Alaska

American Association of State Highway and Transportation OfficialsAdministrative Subcommittee on Internal/External Audit, 2001–2002

Chair David G. Campbell, IllinoisVice Chair Owen Whitworth,TexasSecretary Lamar McDavid, AlabamaAASHTO Liaison Roger Roberts

State MemberAlaska Robert W. Janes CPAArizona Les Maurseth CPAArkansas William H. McDormanCalifornia Diane EidamColorado Casey TigheConnecticut Dave F. Crowther

William P. SchollDelaware Bill Gallant

Robert UhleDistrict ofColumbia Pamela GrahamFlorida Cecil T. Bragg Jr., CPAGeorgia Jerry M. SatterfieldHawaii Bert NishimuraIdaho Carolyn A. Rosti CPAIllinois Randy K. VereenIndiana Ed S. KingIowa Donald M. BrenimanKansas Dale Jost

Eugene W. Robben CPAKentucky J. W. Bryan

Jerry WhitehouseRussell Wright

Louisiana J. Preston PerillouxMaine Richard AlessandroMaryland Gordon L. KennardJr.

Joseph J. LambdinRomut Shah

Massachusetts Michael J. ByrneMichigan Jerry J. JonesMinnesota Ronald W. GippMississippi P. Diane GavinMissouri Roberta BroekerMontana J. Dennis SheehyNebraska James A. DietschNevada Jeff Rauh MBA, CIA, CISHNew Hampshire Douglas S. RowdenNew Jersey Ronald W. BerschNew Mexico Mike MieraNew York John S. SamaniukNorth Carolina Bruce Dillard

Wanda OakleyNorth Dakota Roberta L. KellerOhio Bob TugendOklahoma John K. ParkerOregon Drummond Kahn

Daniel J. MotleyPennsylvania Frank J. BreinerPuerto Rico Vicente GuzmanRhode Island James R. Choquette

Joseph P. Murphy

South Carolina Sherry BartonDouglas McFarlane

South Dakota Tim P. Flannery CPATennessee Nancy A. Bernstein

Janice MavstonUtah Stephen C. ReitzVermont Michael R. PollicaVirginia Alex SaboWashington Wayne H.DonaldsonWest Virginia George Karr CPA

Randall WadeWisconsin Dennis J. SchultzWyoming Jennifer Jessen

US DOT MemberU.S. DOT Lawrence H. WeintrobFHWA John Jeffers

Affiliate MemberNew Brunswick Dale WilsonSaskatchewan Curtis Goodfellow

Associate MemberN.Y. State Bridge Authority

Michael A. BucciMTA Bridges & Tunnels

Catherine SweeneyN.Y. State Bridge Authority

Douglas D. Garrison

AASHTOUniform Audit & Accounting GuideFor Transportation ConsultantsDecember 2001 1/3/2002

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Uniform Audit & Accounting GuideTable of Contents

Page

Chapter 1 IntroductionAbout This Guide................................................................................1-1

Chapter 2 BackgroundAudit Types........................................................................................2-1

Indirect Cost Rate-Cost Incurred ............................................2-1Indirect Cost Rate-Forward Pricing.........................................2-2Contract Pre-Award...............................................................2-2Contract Cost.........................................................................2-3Auditing Standards..................................................................2-3

Chapter 3 Cost PrinciplesFederal Acquisition Regulations, Part 31..............................................3-1

Reasonableness ......................................................................3-2Allocability..............................................................................3-2Unallowable Costs..................................................................3-3Direct Costs ...........................................................................3-3Distribution Base.....................................................................3-3Base Period............................................................................3-3

Chapter 4 Cost AccountingAllocation Bases.................................................................................4-1

Direct Labor Cost...................................................................4-1Direct Labor Hours.................................................................4-1Total Labor Hours ..................................................................4-1Total Costs.............................................................................4-1Total Cost Value Added.........................................................4-2Usage.....................................................................................4-2

Cost Centers ......................................................................................4-2Functional Cost Centers..........................................................4-2Subsidiaries, Affiliates & Geographic Locations .......................4-2

Allocated Costs ..................................................................................4-2Fringe Benefits........................................................................4-2Overhead ...............................................................................4-2General & Administrative ........................................................4-3Computer/CADD Costs .........................................................4-3Fleet or Company Vehicles.....................................................4-3Equipment ..............................................................................4-3Printing/Copying/Plan Reproduction........................................4-3


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Direct Labor ...................................................................................... 4-3Uncompensated Overtime Pay............................................................ 4-4Compensated Overtime Pay............................................................... 4-5Other Labor Considerations ............................................................... 4-5Contract Labor .................................................................................. 4-7Other Direct Costs ............................................................................. 4-7Field Office Rates............................................................................... 4-8Field Office Indirect Costs.................................................................. 4-8

Chapter 5 Selected Items of CostAdvertising & Public Relations............................................................ 5-1Bad Debt & Collection....................................................................... 5-2Compensation.................................................................................... 5-2

Reasonableness...................................................................... 5-2Incentive Compensation (Bonuses) ......................................... 5-2Compensation Limits (Executive Compensation) ..................... 5-3Pension Plans ......................................................................... 5-3Employee Stock Ownership Plans(ESOPS)............................ 5-4Severance Plans ..................................................................... 5-4Personal Use of Company Vehicles ........................................ 5-5Contributions or Donations ..................................................... 5-5

Facilities Capital Cost of Money(FCCM) ........................................... 5-5Employee Morale, Health & Welfare.................................................. 5-6Entertainment ..................................................................................... 5-7Fines & Penalties................................................................................ 5-7Bid & Proposal.................................................................................. 5-7Insurance (Key-Man & Re-Work) ..................................................... 5-7Interest Costs..................................................................................... 5-8Lobbying Costs.................................................................................. 5-8Losses on Other Contracts ................................................................. 5-8Organization & Reorganization Costs.................................................. 5-8Patent Costs....................................................................................... 5-8Retainer Fees ..................................................................................... 5-9Relocation (of employees) Costs......................................................... 5-9Rent/Leases ....................................................................................... 5-9Selling Costs .................................................................................... 5-10Travel Expenses............................................................................... 5-10Legal Costs...................................................................................... 5-11Business Combination Costs............................................................. 5-11Alcoholic Beverages......................................................................... 5-11

Chapter 6 Management’s Responsibility for AccountingSchedule of Indirect Cost ................................................................... 6-1Unallowable Costs ............................................................................. 6-2


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Financial Statements............................................................................6-2Disclosures.........................................................................................6-3Management Representations..............................................................6-3

Chapter 7 Audit ConsiderationsInternal Controls ....................................................................7-1 thru 7-3Understanding the Consultant’s Business .............................................7-3Consideration of Other Financial and Contract Audits..........................7-4Electronic Data Processing..................................................................7-4Audit Risk and Materiality...................................................................7-5Type and Volume of Contracts...........................................................7-5

Chapter 8 Audit ProceduresLabor Costs .......................................................................................8-1Allocated Costs ..................................................................................8-2Other Direct Costs..............................................................................8-2Other Audit Procedures ......................................................................8-3

Chapter 9 ReportingAuditors Reports ................................................................................9-1

Report on Schedule of Indirect Costs ......................................9-2Schedule of Indirect Costs ......................................................9-8Criteria Description for FARs References & OtherAudit Adjustments ..................................................................9-9Notes to Schedule of Indirect Costs ......................................9-10

Report on Internal Control (includes examples):1. With No Reportable Conditions .........................................9-32. With Reportable Conditions which are MaterialWeaknesses; ............................................................... 9-4 & 9-53. With Reportable Conditions which are notMaterial Weaknesses................................................... 9-6 & 9-7

Disclosure Notes and Examples ........................................................9-11Description of the Company & Accounting Policies ..............9-12Labor-Related Costs ..............................................9-13,14 & 15Facilities Capital Cost of Money (FCCM).............................9-15Depreciation.........................................................................9-16Related Party Transactions....................................................9-16Auditor Contact Information..................................................9-16

Chapter 10 Cognizant AuditsNHS Act - Section 307 Cognizant Audits .........................................10-1Guidelines for Reviewing CPA Indirect Cost Audits...........................10-3


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Appendix A State Cost Principles-State Contacts &Acknowledgements

Appendix B Glossary

Appendix C Listing of Resource MaterialsGovernment Auditing Standards (“Yellow Book”) ..............................C-1Federal Acquisition Regulations ..........................................................C-1DCAA Contract Audit Manual...........................................................C-2American Institute of Certified Public Acountants (AICPA).................C-2Accounting Standards - Current Text (FASB).....................................C-4

Appendix D Listings, Tools and ExamplesListing of Common Unallowable Expenses..........................................D-2Schedule of Indirect Costs – Example With Field Rates.......................D-3

Uniform Audit & Accounting GuideFor Transportation ConsultantsDecember 2001 1/3/2002

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Chapter One - Introduction, About This Guidehis guide has been developed by the American Association of StateHighway and Transportation Officials (AASHTO) Audit Subcommitteewith assistance from the American Council of Engineering Companies(ACEC) Transportation Committee and the Southern Resource Center of

the Federal Highway Administration (FHWA). The AASHTO AuditSubcommittee is comprised of the chief of audits for each state’s transportation orhighway department. This guide was approved by AASHTO at the organization’s2001 annual meeting and has been endorsed by the ACEC TransportationCommittee.

An electronic version of this guide can be found on the AASHTO home page:www.transportation.org

The purpose of the audit guide is to provide a tool that can be used by individualstate auditors, consulting firms and public accounting firms that perform audits ofconsulting firms. The primary focus of the guide is auditing and reporting on theindirect costs and resultant overhead rates of consultants who perform engineeringand engineering-related work for state Highway Agencies.

This guide is not intended to be an auditing procedures manual but rather a guidethat will assist individuals in understanding terminology, policies, audit techniquesand sources for regulations and specific procedures.

Note: Individual acknowledgements are included in Appendix A.

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Chapter Two - BackgroundMost State Highway Agencies (SHAs) award contracts for engineering andrelated services using Qualifications Based Selection (QBS) procedures. UnderQBS, consultant selections are based solely on elements of qualification withoutconsideration of price. Consultants do not submit bids or priced proposals to beused as a basis for selection. Once the SHA has made a selection based on theconsultant’s qualifications, prices are negotiated based on the consultant’s actualcost and must be a reasonable price for the work to be performed.

Federal law [23 USC Sec. 112 (b) (2) (C)] requires that contracts for engineeringservices be performed and audited in compliance with costs principles contained inthe Federal Acquisition Regulations (FARs). Because most SHAs constructhighway improvements using both state and federal funds, most have state rules forselection and pricing of state-funded consultant contracts that incorporate or aresimilar to federal rules.

The timing and types of audits performed to meet federal requirements may varybetween states and contracts depending on state procedures and othercircumstances. The audits are performed to ensure that consultant contract pricingis based on actual costs incurred in compliance with the Federal AcquisitionRegulations as well as specific contract provisions.

Contract Audits generally fall within the following categories.

Audit TypesINDIRECT COST RATE (COST INCURRED) AUDIT

This type of audit is performed to render an opinion on the consultant’sindirect cost rate(s) for a specified period (usually a fiscal year). In additionto making sure that unallowable costs have been removed from overhead,the auditor must also make sure that allowable costs have been correctlymeasured and properly allocated. Rates audited are used to retroactivelyadjust costs previously invoiced at provisional rates to actual cost. ManySHAs also use audited indirect cost rates of the most recently completedfiscal year as a provisional rate to be used for estimating and invoicing costson new contracts. Audit risk and materiality for this type audit would be

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measured with consideration given to all contracts that may be priced usingthe indirect cost rate.

INDIRECT COST RATE (FORWARD PRICING) AUDIT

This type of audit is performed to render an opinion on the consultant’sforward pricing indirect cost rate(s) used to prepare estimates of costs thatwill be incurred in future periods. Forward pricing rates are similar to costincurred rates in that they have a basis in historical costs. However,forward pricing rates are adjusted to reflect estimates of future costs andactivity levels to project indirect cost rates for future periods. Audits offorward pricing rates must evaluate the reasonableness of future projectionsas well as the accuracy of historical cost information used as the startingpoint for the rate development. While most contracts negotiated directlywith the federal government utilize forward pricing rates, many SHAs willonly negotiate contracts using indirect cost rates based on historicalinformation. Audit risk and materiality for this type audit should bedetermined with consideration given to all contracts which may be pricedusing the indirect cost rate

CONTRACT PRE-AWARD REVIEW

Contract pre-award reviews are performed to evaluate the reasonableness andaccuracy of a cost proposal for a specific contract. The auditor may examinethe reasonableness of estimates used as well as the accuracy of estimatecomponents that are based on current or historical costs. When conductingpre-award reviews, auditors often rely on work done in indirect cost rateaudits. If other audits don’t exist, auditors performing the pre-award reviewmay examine items like indirect cost rates. Audit risk and materiality shouldbe determined with consideration only to the contract being covered by thepre-award. Additional audit work may be necessary for very large contracts.

CONTRACT COST AUDITCost audits are performed to render an opinion on cost incurred under actualcost contracts. The auditor may examine both direct and indirect costs todetermine whether costs invoiced were allowable under applicable costprinciples and treated consistently with cost accounting practices used todevelop the consultant’s indirect cost rate(s). When conducting “final” costaudits, auditors often rely on work done in indirect cost rate audits. Inaddition to using the indirect cost rate, the auditor may be able to rely on


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evaluation and testing of accounting systems that were performed duringindirect cost rate audits.

If other audits don’t exist, auditors may consider work performed during thepre-award review. Audit risk and materiality for this type of audit should bedetermined with consideration only to the contract(s) being covered underthe contract cost audit.

Auditing StandardsGovernment Auditing Standards (“Yellow Book”) published by the ComptrollerGeneral of the United States of America apply to audits of government entities andgovernment assistance paid to contractors, non-profit organizations and other non-governmental organizations. These standards are often referred to as “generallyaccepted government auditing standards” (GAGAS). Consultant indirect cost rateaudits fall within the category of “financial related audits” under GAGAS. Theaudit of a consultant’s indirect cost rate is an audit of a special purpose financialpresentation to comply with a contractual requirement.


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Chapter Three - Cost PrinciplesFederal Acquisition Regulations (FARs)State Highway Agencies (SHAs) rely on the Federal Acquisition Regulations(FARs), Title 48, Chapter 1, Part 31 -- Contract Cost Principles and Procedures forguidance when negotiating costs and reviewing project proposals with consultants.The FARs contain cost principles and procedures for pricing contracts,subcontracts, and modifications to contracts. In addition, the FARs may also beused in the determination, negotiation or allowance of costs when required by acontract clause.

The following is a general discussion of applicable cost principles described in Part31 of the FARs. This discussion is on a summary level only and is not intended tobe a complete rendition of all cost principles contained in the FARs.

The provisions apply to commercial organizations, educational institutions, state,local and federally recognized Indian tribal governments and nonprofitorganizations. Subpart 31.105, dealing with construction and architect-engineeringcontracts, states that the allowability of costs shall be determined in accordancewith Subpart 31.2. For the purpose of our discussion, we will focus on Subpart31.2 - Contracts with Commercial Organizations.

The total cost of a contract includes all costs properly allocable to the contractunder the specific contract provisions. The allowable costs to the government arelimited to those costs which are allowable pursuant to Part 31.

In some cases, the contracting state may enter into an advance agreement with aconsultant to clarify the allocability and allowability of special or unusual costs.Subpart 31.109 provides further clarification of advance agreements, includingexamples of costs for which advance agreements may be important.

In the absence of any advance agreements, the auditor must determine theallowability of costs. To determine the allowability, the auditor should considerthe following:

1 .1 . Any limitations set forth in Subpart 31.2 of the FARs.

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2 .2 . Allocability;

3 .3 . Standards promulgated by the Cost Accounting Standards Board(CAS); if applicable, otherwise, Generally Accepted AccountingPrinciples and practices appropriate to the particularcircumstances;

4 .4 . Terms of the contract; and

5 .5 . Reasonableness.

A cost is reasonable if, in its nature and amount, it does not exceed that whichwould be incurred by a prudent person in the conduct of competitive business. Thereasonableness of specific costs is not always easy to determine since such adetermination depends to some extent on judgment and interpretation of the FARs.

Reasonableness depends upon a variety of considerations and circumstances,including the following:

1 .1 . Whether the cost is generally recognized as ordinary andnecessary for the conduct of business or the contractperformance;

2 .2 . Generally accepted sound business practices, arm’s lengthbargaining, and federal and state laws and regulations;

3 .3 . The consultant’s responsibilities to the government, othercustomers, the owners of the business, employees and the publicat large; and

4 .4 . Any significant deviations from the firm’s established practices.

A cost is allocable if it is assignable or chargeable to one or more cost objectives orcost centers on the basis of relative benefits received or some other equitablerelationship. A cost must be distributed in some reasonable proportion to thebenefits derived. A cost is allocable to a government contract if it:

1 .1 . Is incurred specifically for the contract;

2 .2 . Benefits both the contract and other work, and can be distributedto them in reasonable proportion to the benefits received; or

3 .3 . Is necessary to the overall operation of the business, although adirect relationship to any particular cost objective cannot beshown.

Costs that are expressly or mutually agreed to be unallowable, including directlyassociated costs, must be identified and excluded from any billing, claim, orproposal applicable to a government contract. A directly associated cost is any cost


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which is generated solely as a result of incurring another cost, and which would nothave been incurred had the other cost not been incurred. When an unallowablecost is incurred, its directly associated costs are also unallowable. The practices toaccount for and present unallowable costs are described in 48 CFR 9904.405,Accounting for Unallowable Costs.

In evaluating a consultant’s overhead, an auditor must consider direct as well asindirect costs. A direct cost is any cost that can be identified specifically with aparticular contract or project. Costs identified specifically with a contract orproject are direct costs and are to be charged directly to the contract or project. Allcosts specifically identified with a project are direct costs of that project and cannotbe charged to another project, either directly or indirectly. Finally, a cost cannot becharged as direct and also be included in any indirect cost pool. For reasons ofpracticality, any small dollar direct cost may be treated as an indirect cost if theaccounting treatment is consistently applied to all projects and producessubstantially the same results as treating the cost as a direct cost.

Indirect costs should be accumulated by logical cost groupings with dueconsideration of the reasons for incurring such costs. Commonly, manufacturingoverhead, selling expenses and general and administrative (G&A) expenses areseparately grouped. The consultant’s method of allocating overhead costs shouldbe in accordance with generally accepted accounting principles, which areconsistently applied.

Some contracts may be subject to Cost Accounting Standards (CAS), which arepromulgated by the Cost Accounting Standards Board(GASB), an agency of theFederal Government within the Office of Management and Budget(OMB).

A distribution base common to all cost objectives or projects is selected forallocation of an overhead or indirect cost pool. Typically, consultants use directlabor as the base for developing overhead rates. Once a base has been established,it should not be adjusted by removing individual components.

The base period for most consultants’ overheads will normally be the firm’s fiscalyear. When a contract is performed over an extended period, as many base periodsshall be used as are required to represent the period of contract performance.


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Chapter Four - Cost AccountingAllocation BasesAn allocation base is the means by which certain overhead or indirect costs aredistributed to final cost objectives. There are a variety of allocation bases whichare commonly used in cost accounting systems for allocating indirect costs,however, for State Highway Agency (SHA) administered engineering contractsdirect labor cost or usage are recommended.

Some of the common methods include:

Direct Labor CostDirect labor cost is the most common and accepted base used to allocateoverhead costs on SHA contracts. Direct labor costs are generally all projecthours multiplied by labor rates and summarized for all employees within theapplicable allocation unit. Labor rates are based on actual employee wagespaid or represent wages effectively paid.

Direct Labor HoursThe direct labor hour method is another way to allocate indirect costs basedon total direct hours charged in an appropriate allocation unit.

Total Labor Hours (Total Hours Worked)This method is similar to Direct Labor Hours allocation base, except that thebase includes all hours incurred for direct and indirect activities. Use of thisbase assumes that costs incurred benefit both direct and indirect objectivesand should be allocated to the appropriate pool receiving a benefit.

Total CostsGenerally, this is the base used to allocate G & A costs. The base consists ofdirect labor, fringe benefits, overhead costs, associated non-salary directexpenses (including other costs sometimes referred to as internal directexpenses) and subcontract costs.

Total Cost Value AddedThis basis is similar to the Total Cost base shown above to allocate G & Acosts. However, the value-added basis excludes materials (used primarily in

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production only) and subcontract costs. Distortion in allocations may occurdue to a disproportionate amount of subcontract costs or materials in thepool.

UsageThis method allocates costs to direct or indirect activities on a common unit,usually time or quantity used. For instance, an internal cost pool such as onefor computer-aided drafting and design equipment (CADD) costs can beallocated specifically as a direct cost to a project or as an indirect cost basedon the number of hours actually incurred.

Cost CentersCost centers are established to accumulate and segregate costs.

Functional Cost CentersThis method segregates costs unique to a business activity, typically forpurposes of direct costing. Examples are CADD costs, vehicles andreproduction services.

Subsidiaries, Affiliates, Divisions & GeographicLocations

Another method is focused on the corporate structure. Some examples ofcost centers used for accumulating costs are groupings of regional offices,specific subsidiaries, affiliates, divisions, or field offices.

Allocated Costs:

Fringe BenefitsFringe benefits are the costs associated with the business’ portion of payrolltaxes and benefits in employment. Such costs generally include, but are notlimited to: payroll taxes, pension plan contributions, medical insurance costs,life insurance and employee welfare expenses.

OverheadOverhead costs are costs that may benefit or are associated with two or morebusiness activities, but are not specifically allocated to an activity for reasonsof practicality. Overhead differs from general and administrative costs(below) in that these costs can be associated with a unit based on benefit.Some examples of overhead costs are rent, depreciation, employeerecruitment and training, and general or professional insurance policy costs.

General and AdministrativeThis expense generally is all costs associated with the entire business’operation, which cannot be specifically identified with a smaller unit of


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business activities. Example: certain management or administration coststhat are incurred for an entire business unit may be considered G & A, butother accounting or legal costs benefiting a segment of the business may beconsidered part of the overhead pool of that specific segment.

Computer/CADD CostsGenerally, this pool includes costs such as equipment depreciation or rental;software including license costs; employee training costs on new software;equipment maintenance; cost of special facilities or locations; and systemsdevelopment labor or support costs.

Fleet or Company VehiclesFor the most part, these costs are company vehicles such as cars, surveytrucks, and vans that may be used for a direct or indirect cost objective.Pooled costs may include depreciation, lease costs, maintenance, insuranceand operation costs such as fuel.

EquipmentCosts accumulated to this pool are similar to both computer and companyvehicle pools. Company equipment can be a wide variety of items from smallto large that are used in various activities.

Printing/Copying/Plan ReproductionCosts in this pool are generally associated with reproduction from a singlepage copied to multiple prints of large specialized drawings or blue prints.The pool in most cases includes equipment, labor, ink or toner, and papersupplies.

Direct LaborLabor costs are usually the most significant costs incurred in the performanceof Government contracts. Incurred labor costs form the basis for estimatinglabor for future contracts. It is, therefore, imperative that consultantsestablish and maintain a sound system of internal control over the laborcharging function.

Unlike other items of cost, labor is not supported by external documentationor physical evidence to provide an independent check or balance. The keylink in any sound labor charging system is the individual employee. It iscritical to labor charging internal control systems that management fullyindoctrinate employees on their independent responsibility for accuratelyrecording time charges. This is the single most important feature managementcan emphasize in recognizing its responsibility to owners, creditors, andcustomers to guard against fraud, waste, and significant errors in the laborcharging functions.

An adequate labor accounting system, manual or electronic, will create anaudit trail whenever an employee creates a timesheet entry. A system that


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allows an audit trail to be destroyed is inadequate because the integrity of thesystem can be easily compromised. Access to timesheets should becontrolled and preprinted, if possible, with the employee’s name, numberand fiscal week. An inadequate system would allow employees to erase priorentries without recording the adjustment; adjustments should be maintainedas part of the audit trail.

The consultant should have policies and procedures for training employees toreasonably assure that all employees are aware of the importance of propertime charging.

Uncompensated OvertimeCompanies may not be required to pay overtime to salaried employeesfor hours worked in excess of 40 hours per week. Any hours worked bysalaried employees in excess of the normal 40 hours per week arecommonly called uncompensated overtime.

The consultant should have procedures to ensure that all hours workedare recorded, whether they are paid or not, to assure the properdistribution of labor costs. This is necessary because labor rates andlabor overhead costs can be affected by total hours worked, not justpaid hours worked.

Acceptable accounting methods for uncompensated overtime:

1. Compute a separate average labor rate for each pay periodbased on the salary paid and the total hours worked. Applythis rate to all cost objectives worked on during the period,including paid absences and indirect activities, to distributethe salary costs.

2. Determine a pro rata allocation of total hours worked duringthe period and distribute the salary cost using the pro rataallocation. If an employee worked 25 hours on one costobjective and 25 hours on another, each cost objectivewould be charged with one-half of the employee’s salary.

3. Compute a standard hourly rate for each employee for theentire year based on the total hours the employee is expectedto work during the year and distribute salary costs to all costobjectives worked on at the standard hourly rate. Anyimmaterial variance between actual salary costs and theamount distributed would be charged/credited to overhead.Material variances would be charged to the cost objective.Billings should be adjusted for material variances.

Any other methods would require further review to determineacceptability.


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Some consultants’ accounting systems may not assign costs to thosehours worked by salaried employees in excess of 8 hours per day or 40hours per week. Because there is a serious risk of mischarging costs togovernment contracts under these circumstances, the followingmethods of distributing these salary costs are unacceptable :

1. Distribute labor costs to only those cost objectives workedon during the first 8 hours of the day.

2. Allow employees to select the cost objectives to be chargedwhen more than 8 hours per day are worked or theconsultant has an informal policy as to how employees are toselect the objectives to be charged.

Contracting state SHAs should be consulted to determine individualstate interpretations where material amounts are involved.

Premium OvertimeConsultants should have the capability of maintaining records thatsegregate overtime premium amounts as direct or indirect costs. Anacceptable method is to charge premium overtime as a direct chargewhen it is the consultant’s regularly established policy and whenappropriate tests demonstrate that this policy results in equitable costallocations. Premium overtime should be excluded from the directlabor base.

When employees normally work on multiple contracts it is oftendifficult to determine which contract “caused” the overtime. In thiscase the overtime premium may be charged to overhead.

Other ConsiderationsThe consultant should have procedures assuring that labor hours areaccurately recorded and that any corrections to time keeping recordsare documented, including appropriate authorizations and approvals.

The consultant should have procedures requiring that the total labordollars reflected in labor distribution summaries agree with the totallabor charges as entered in the time-keeping and payroll systems. Thisreconciliation ensures the labor charges to contracts represent actualpaid or accrued costs and that such costs are appropriately recorded inthe accounting records.

The consultant should have procedures requiring that direct andindirect labor costs directly associated with unallowable costs areidentified and segregated.


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Areas o f Po tent ia l R i sk

1. Overrun Contracts. When contract costs have exceeded orare projected to exceed contract value, these excess costsshould not be diverted to other cost objectives such asindirect labor, overhead accounts or other contracts.

2. Significant Increases in Direct/Indirect Labor Accounts.Trend analyses may disclose instances where charges todirect or indirect labor accounts have increased significantly.Sufficient review should be performed to determine thenature of the increase.

3. Reorganization/Reclassification of Employees. Theorganizational structure of the consultant should be analyzedto determine if it permits inconsistent treatment of similarlabor. For example, a program manager should not chargedirect on cost-type contracts and indirect on fixed-price/commercial contracts.

4. Adjusting Journal Entries/Exception Reports (LaborTransfers). Adequate rationale and supportingdocumentation should be available for all significant labortransfers.

5. Budgetary Control. Consultants may operate managementsystems that require strict adherence to budgetary controls.If the system is inflexible, labor charges may have a tendencyto follow the identical route of the budgeted amounts. Rigidbudgetary control systems can result in predetermined laborcharges.

6. Mix of Contracts. Costs should be identified and chargedconsistently in the accounting system regardless of type ofcontract.

So le P rop r ie to rs ’ and Pa r tne rs ’ Sa la r i es

The compensation of owners or partners must be charged as directlabor when they are personally engaged in performing under contracts.Salaries must be determined by advance agreements or negotiation.Please refer to each individual state policy for more specificrequirements regarding treatment of this compensation.

Contract LaborIn some cases firms contract for services provided by engineers,technicians, etc. rather than hire individuals as employees. This iscommonly referred to as “Purchased Labor”. The accounting treatmentvaries, depending on the circumstances under which the purchased


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labor costs are incurred.

CAS 418 requires that pooled costs be allocated to cost objectives inreasonable proportion to the causal or beneficial relationship of thepooled costs to cost objectives. Purchased labor must share in anallocation of indirect expenses where such a relationship exists and theallocation method must be consistent with the consultant’s disclosedaccounting practices. A separate allocation base for purchased labormay be necessary to allocate significant costs to purchased labor, suchas supervision and occupancy costs, or to eliminate other costs, such asfringe benefits, that do not benefit purchased labor.

Other Direct Costs-Outside Vendors/Employee ExpenseReports

Other Direct Costs typically include subcontracts, travel, long distancephone calls, and outside printing. Costs based on charge-out ratesdeveloped by the company, typically mileage and copying, areaddressed elsewhere. In order to be treated as a direct cost, the itemmust have been needed for and used on that job, the “but-for”principle. But for this job, the cost would not have been incurred. Allsimilar costs must also be treated as direct costs.

Field Office RatesField offices may exist in several forms. Regardless of the consultant’sorganization, consistency in allocating costs to cost objectives iscritical.

A consultant’s employees may work for a period of time in an on-siteoffice maintained by the SHA. Since the consultant’s employees arenot working out of their own offices and are not receiving officesupport in their day to day activities, the hours billed for them do notqualify for the consultant’s full overhead rate.

The purpose of the field rate is to pay the consultant for the fringebenefits and home office support they do provide to their fieldemployees.

Approved costs directly identified with the project and consistentlytreated as direct costs in the consultant’s accounting records will beallowed as direct project costs. If a cost is not specifically incurred for aproject and identified with that project, it may not be claimed as adirect cost. However, it may be allowed as part of the indirect costsallocated to the field office indirect cost pool.

F ie ld O f f i ce Ind i rec t Cos ts

As a general rule, SHAs do not require extensive staffing of


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consultants’ field offices. Most administrative and managementfunctions will be performed in the home or branch office. Therefore, anequitable portion of these offices’ indirect costs should be allocated tothe field office. The costs that are allocated and the basis for theallocation depends largely on the consultant’s customary accountingpractices. Some SHAs require separate cost centers for accumulation offield office costs.

Fringe Benefits. The fringe benefits applicable to the field officedirect labor costs should be allocated to the field office overhead pool.If the consultant’s accounting records do not maintain separateaccounts for field office fringe benefits, the fringe benefits should beallocated on a direct labor basis (e.g., field office direct labor dividedby total direct labor).

Indirect Labor. Indirect salaries (accounting, legal, purchasing,personnel, management, etc.) are allocated to the field office overheadpool on a direct labor basis:

Direct Field Labor / Total Direct Labor = Allocation A

This percentage is applied to expenses common to both field and homeoffice direct labor in equal proportions. The accounts typicallyallocated by this percentage include indirect salaries, payroll taxes,group insurance, paid leaves, etc.

Indirect Expenses. As a general rule, home or branch office indirectexpenses are allocated to the field office overhead pool on a percentagebasis that is determined by dividing the allocated indirect labor by thetotal home or branch labor:

Indirect Salaries X Allocation A = Allocation BHome Office Direct Labor + Indirect Salaries

After the calculations are made, the allocations are applied to thevarious line item accounts identified in a firm’s overhead schedule.

Note: An example of a Schedule of Indirect Costs including FieldOffice rates is included in Appendix D.


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Chapter Five - Selected Items of CostThe purpose of this chapter is to provide guidance for selected items of cost. It isorganized by FAR Part 31.2 sub-sections in ascending order, numerically. It is notmeant to be authoritative or to supersede the FARs. The entire text of the FARsshould be consulted when determining proper accounting treatment (see AppendixC for sourcesAdvertising & Public Relations (FAR 31.205-1)

Advertising CostsThe only advertising costs allowable are costs for:

• recruiting personnel required for performing contractual obligations;

• acquiring scarce items for contract performance;

• disposing of scrap items for contract performance;

• costs of activities to promote sales of products normally sold to theU.S. government, including trade shows, which contain a significanteffort to promote exports from the United States, or

• employee recruitment costs in accordance with FAR 31.205-34.

Even those advertising costs that are allowable must be reasonable,allocable, and properly assigned to cost objectives.

Allowable advertising can recruit direct as well as indirect labor. Costs ofrecruiting employees with skills needed only for commercial contracts areunallowable, however. Costs are considered unallowable when no specificvacancies are to be filled or if the advertising done is out of proportion to thenumber or importance of the positions to be filled.

Trade Show Expenses and LaborExpenses and labor pertaining to trade shows and other special events aregenerally unallowable except as described above under advertising costs topromote export sales.

Chapter

5


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Public Relations CostsPublic relations include functions and activities dedicated to enhancing anorganization’s image or products and maintaining or promoting favorablerelations with the public.

Specifically, costs of promotional material, motion pictures, videotapes,brochures, handouts, and magazines that are designed to elicit favorableattention to the contractor are unallowable unless used primarily foremployee training and orientation. Costs of memberships in civic andcommunity organizations and costs of souvenirs, models, imprinted clothing,buttons and other momentos provided to customers or the public are alsounallowable.

Allowable public relations costs include costs incurred for (a) responding toinquiries on company policies and activities; (b) communicating with thepublic, press, stockholders, creditors, and customers; and (c) conductinggeneral liaison with news media and government public relations officers, tothe extent that such activities are limited to communication and liaisonnecessary to keep the public informed on matters of public concern such asnotice of contract awards, plant closings or openings, employee layoffs orrehires, and financial information.

Bad Debts & Collection (FAR 31.205-3)Bad debts, including actual or estimated losses arising from uncollectible accountsreceivable due from customers and other claims, and any directly associated costssuch as collection and legal costs are unallowable.

Compensation (FAR 31.205-6)Reasonableness

Costs must be reasonable in amount considering what is normal for acomparable business, the established compensation plan or practice of agiven contractor, or restraints imposed by business circumstances.

The government can challenge either the reasonableness of individualcomponents of employee compensation or the reasonableness of totalcompensation costs.

Incentive Compensation (Bonuses)The following types of bonuses and incentive compensation are usuallyallowable: incentive compensation for management employees, cashbonuses, suggestion awards, safety awards, and incentive compensationbased on production, cost reduction, or efficient performance. To beallowable, business or incentive compensation must be:


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1. granted under an agreement entered into in good faith betweenthe employer and the employee, before the services arerendered; or

2. granted pursuant to an established plan or policy followedconsistently (to the point of implying an agreement).

The government sometimes challenges bonus plans that are not based strictlyon production, cost reduction, or efficient performance.

Bonuses for officers of closely held corporations should be reviewed carefullyto ensure they are not dividends that would be considered distribution ofprofits. Distributions of profits are unallowable for inclusion in either director indirect labor costs.

Compensation Limits (Executive CompensationBenchmarks)

In addition to reasonableness, executive compensation is specifically limitedby the FARs and the limits can be found at the DCAA web site,www.dcaa.mil (see Appendix C). The Office of Management and BudgetAdministrator, pursuant to Section 808 of Public Law 105-85, determinethese limits periodically. The term compensation includes wages, salary,bonuses, deferred compensation, and employer contributions to definedpension plans. The cost rule is applied to the senior executives at corporateoffices and business segments. Maximum limits for contract costs incurredafter the following effective dates are as follows:

Compensation Maximum Limits:

July 1, 1996 $200,000January 1, 1997 $250,000January 1, 1998 $340,650January 1, 1999 $342,986January 1, 2000 $353,010January 1, 2001 $374,228

Pension PlansPension plan expenses are complicated so that FARs, IRS regulations andCAS regulations must be carefully reviewed in order to determine allowabilityof costs. Generally, a pension plan is a deferred compensation plan thatprovides for systematic payment of benefits that are paid for life, or givesemployees the option for benefit payments for life. Qualified pensionplans are definite written programs that meet the criteria as set forth by theInternal Revenue Code. All other pension plans are considered unqualifiedpension plans. Costs for either types of plans may be allowable dependingon the specific circumstances.


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One of the critical FARs requirements is that, for pension costs to beallowable in the current year, they must be funded by the due date for filingthe federal income tax return. Pension costs assigned to the current year butnot funded on time are unallowable in any subsequent year.

The amount contributed to qualified pension or profit sharing plans on behalfof principals and employees is allowable. However, the payments must bereasonable in amount and be paid pursuant to an agreement entered into ingood faith between the contractor and employees, before the work or servicesare performed and pursuant to the terms and conditions of the establishedplan.

Costs of changes that are discriminatory to the government or that are notintended to be applied consistently in the future are unallowable. One-time-only pension supplements not available to all plan participants are generallyunallowable, unless the supplemental benefits represent a separate pensionplan and the benefits are payable for life at the employee’s option. Increasedpayments to retired participants for cost-of-living adjustments are allowableif paid in accordance with a consistent policy or practice.

Employee Stock Ownership PlansEmployee stock ownership plans (ESOPs) are an individual stock bonus plandesigned specifically to invest in the stock of the employer corporation. Thecontractor’s contributions to an employee stock ownership trust (ESOT) canbe in the form of cash, stock, or property. The purpose of an ESOP may befor deferred compensation or for a supplementary pension plan; each wouldbe covered by different regulations.

Severance PlansSeverance pay or dismissal wages are extra payments made to employeeswhose employment is involuntarily terminated. Severance pay does notinclude payments under early-retirement incentive plans.

Severance pay is allowable only when payment is required by (1) law, (2)employer-employee agreement, (3) established policy that is, in effect, animplied agreement on the contractor’s part, or (4) circumstance of theparticular employment. Normal severance pay relates to recurring, partiallayoffs, cutbacks, and involuntary separations and is an allowable cost whenproperly allocated.

“Normal severance” refers to routine employee terminations. “Abnormalseverance” refers to any mass termination of employees, which is usuallyunpredictable. Actual costs of normal severance pay must be allocated to allwork performed at the contractor’s facility. Accruals of normal severancepay are acceptable (1) if the amount is reasonable in light of prior experience,and (2) if it is allocated to both government and nongovernment work.Abnormal severance, however, is unallowable as an accrued cost because ofthe conjectural nature of the cost.


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Special compensation to terminated employees after a change in managementcontrol is unallowable to the extent that it exceeds normal severance pay(“golden parachute”). Special compensation contingent on the employeeremaining with the organization after a change in management control is alsounallowable (“golden handcuff”).

Personal Use of Company VehiclesThis cost is unallowable, including the portion of cost related totransportation to and from work.

Contributions or Donations (FAR 31.205-8)Contributions in the form of cash, property and services are unallowableexcept for costs of participation in community services such as blood bankdrives, charity drives, disaster assistance, etc..

Cost of Money (FAR 31.205-10)This is an imputed cost related to investment in facilities used in contractperformance whether the source of the investment is equity or borrowed capital.The resulting cost of money is not a form of interest on borrowing.

The costs of the capital investment must be determined, measured and allocated tocontracts in accordance with CAS 414.

The estimated facilities capital cost of money must be specifically identified in thecost proposals relating to the contract under which the cost is to be claimed.

Accounting for the facilities cost of money is generally through a memorandumentry of the cost. The contractor must maintain, in a manner that permits audit andverification, all relevant schedules, cost data, and other data necessary to supportthe entry fully.

The cost of money rate is the arithmetic mean of the interest rates specified by theSecretary of the Treasury. These are published in the Federal Register aroundJanuary 1 and July 1. For a fiscal year ending December 31, the arithmetic meanwould be the simple average of the rates for the January 1 through June 30 periodand the July 1 through December 31 period.

The average book value of the investment base is multiplied by the cost of moneyrate. The resultant value is divided by the allocation base units (such as direct laborhours, or dollars of total cost input) for the corresponding indirect cost pool.

Appendix A to CAS 414 contains the form for Facilities Capital Cost of Money andAppendix B to CAS 414 contains a detailed example in which the total cost ofmoney on facilities capital is computed on a step-by-step basis.


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Employee Morale, Health &Welfare (FAR 31.205-13)Employee welfare and morale expenses incurred on activities to improve workingconditions, employer-employee relations, employee morale, and employeeperformance are allowable. Expenses and income generated by employee welfareand morale activities should be in compliance with FARs 31.205-13. Note thatemployee morale type expenses are often covered by the entertainment costprinciple, 31.205-14. FAC 90-31, effective October 1, 1995 clarified thatentertainment costs are unallowable under any cost principle, without exception.Consequently, the entertainment cost principle at FARs 31.205-14 takesprecedence over any other cost principle.

Although gifts are an expressly unallowable expense, the cost principlespecifically excludes two categories of awards from the unallowable giftdefinition:

1. Awards covered by the compensation cost principle FAR31.205-6; and

2. Awards made pursuant to an established plan or policy forrecognition of employee achievements.

Recreation expenses are an expressly unallowable expense unless the cost claimedmeets the following criteria:

1. The cost is for employee participation in a sports team or employeeorganization.

2. The team or organization is company sponsored.

3. The team’s or organization’s activity is designed to improvecompany loyalty, team work, or physical fitness.

Costs incurred for employee welfare and morale, less credits for income generatedby these activities, are allowable to the extent that the net amount is reasonable.Reasonableness is considered in nature and amount both for the contractor as awhole and for the employee(s) benefited by the expenditure.

Whether or not the IRS has recognized certain costs as deductible businessexpenses for Federal income tax purposes is not necessarily determinative of theirallowability under government cost-reimbursement type contracts where such costsfail to satisfy allowability or reasonableness criteria.

Types of activities that fall under this subsection are very restrictive and limited.Examples of allowable activities are house publications, health clinics,wellness/fitness, employee counseling services, and food and dormitory services.

Entertainment (FAR 31.205-14)Costs of amusement, diversions, social activities and any directly associated costssuch as tickets to shows or sports events, meals, lodging, rentals, transportation,


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and gratuities are unallowable. Costs of membership in social, dining, countryclubs or other organizations having the same purposes are also unallowable,regardless of whether the cost is reported as taxable income to the employees.

Fines & Penalties (FAR 31.205-15)Costs of fines and penalties resulting from violations of, or noncompliance with,Federal, State, local or foreign laws and regulations, are unallowable except whenincurred as a result of compliance with specific terms and conditions of thecontract or written instructions from the contracting officer.

Bid & Proposal (FAR 31.205-18)The composition of bid and proposal costs is often a key issue. Althoughmarketing costs are very similar to bid & proposal costs, basic bid & proposal costsare incurred in preparing specific documents, whereas selling and marketing costsare more general in nature. Therefore, a contractor should establish procedures forsegregating bid & proposal costs from selling and marketing costs.

Bid & proposal costs are allowable and should be treated as indirect costs unlessthe contract requires submission of a proposal for subsequent work and authorizesthe costs to be charged directly to that contract.

Pre-contract costs are those costs that are considered as part of the direct costsof the contract, but are incurred prior to execution of the contract. These costs areunallowable as indirect costs.

Insurance, Key-Man Life & Re-Work (FAR 31.205-19)“Key-man life insurance” is insurance on the lives of officers, partners orproprietors and it is considered an unallowable expense unless the insurance isincluded as additional compensation.

“Re-work insurance” is casualty insurance to protect the contractor against thecosts of correcting its own defects, and is considered unallowable.

Interest Costs (FAR 31.205-20)Interest on borrowings (however represented), bond discounts, costs of financingand refinancing capital (net worth plus long-term liabilities), legal and professionalfees paid in connection with preparing prospectuses, costs of preparing and issuingstock rights, and directly associated costs are unallowable except for interestassessed by state or local taxing authorities under the conditions specified in31.205-41.

Lobbying Costs (FAR 31.205-22)Lobbying and political activity costs are generally unallowable. Some examples ofthese types of costs are activities that attempt to influence the outcomes ofFederal, state or local elections, contribute to political parties or organizations,


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influence Federal, state or local legislation, influence legislative liaison activities orinfluence employees of the executive branch of government.

Certain activities may be allowable if detailed records are maintained They mayinclude activities such as testifying at hearings, providing technical information ontopics directly related to contracts, or lobbying activities that may directly reducecontract cost.

Losses on Other Contracts (FAR 31.205-23)Any excess of costs over income under any other contract (including thecontractor’s contributed portion under cost-sharing contracts) is unallowable.

Organization & Reorganization (FAR 31.205-27)All expenditures in connection with planning or executing the organization orreorganization of the corporate structure of a business, including mergers andacquisitions, or raising capital are unallowable. The exception to this is under (b),the cost of activities primarily intended to provide compensation. These costs willnot be considered organizational costs but are governed by FAR 31.205-6.

The rationale for disallowing these costs is that the government entered into acontract with a specific entity considered competent to perform the work andshould not reimburse the costs of corporate changes not incident to contractperformance.

Patent Costs (FAR 31.205-30)Patent costs not required by the government contract are unallowable.

Certain costs may be allowable if they are incurred as a requirement of agovernment contract. They include costs such as preparing disclosures, filingdocumentation, searching records and counseling related to general patent matters.

Retainer Agreements (FAR 31.205-33)Work performed by professionals and consultants with special skills are allowablebut must be supported by detailed evidence of the nature and scope of the workperformed. However, retainer agreements which are not based on specificstatements of work performed are unallowable.

Relocation Costs (FAR 31.205-35)Certain costs of relocating permanent employees are allowable if numerousrequirements are met. Some examples of the conditions which would cause thecosts to be unallowable are:

• mortgage-related costs if employees were not homeowners prior to the move

• if the move was for a period of time less than 12 months


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• the move does not benefit the employer

• employer does not have a consistent relocation policy for all employees

• costs represent loss on sale of a home

• continuing mortgage principal payments on sold residence

Rent/Lease (FAR 31.205-36)The most common form of renting or leasing real or personal property is via anoperating lease where the consultant pays rent to a third party at prevailingmarket rates. These costs are generally allowable.

However, in some cases, property is considered a “purchased asset” and must beaccounted for as a capital lease. In the case of a capital lease the capitalized valueof the assets must be distributed over their useful life as depreciation charges, orover the term of the lease as amortization charges. Criteria were established byFAS-13 in paragraph .007, which classifies leases. If a lease meets one or more ofthe following four criteria, the lease shall be classified as a capital lease.Otherwise, it shall be classified as an operating lease.

1. The lease transfers ownership of the property to the lessee by theend of the lease term.

2. The lease contains a bargain purchase option.

3. The lease is equal to 75% or more of the estimated economic life ofthe leased property.

4. The present value at the beginning of the lease term of the minimumlease payment (with certain exclusions) equals or exceeds 90% ofthe fair value of the leased property to the lessor at the inception ofthe lease over any related investment tax credit retained by thelessor and expected to be realized by him.

Common control is another important issue when considering the allowability ofrental costs. Charges in the nature of rent for property between any divisions,subsidiaries, or organizations under common control, are allowable to the extentthat they do not exceed the normal costs of ownership, such as depreciation,taxes, insurance, facilities capital cost of money, and maintenance, provided that nopart of such costs shall duplicate any other allowed cost.

Selling Costs (FAR 31.205-38)Selling costs are allowable if reasonable.

Selling and marketing costs cannot be adequately identified by mere reference toaccount titles. Such a shallow analysis is not sufficient to assess the allocabilityand allowability of costs within an account. The actual composition of the accountor the activities it represents must be known and analyzed.


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Any selling and marketing costs are subject to government challenge if the costscan be considered unnecessary for government contracts. In determining thereasonableness of selling costs, the government considers the nature and amount ofthe expense in light of the expenses that a prudent individual would incur in acompetitive business, the proportionate amounts expended as between governmentand commercial business, the trend and comparability of current costs withhistorical costs, the general level of selling costs in the industry, and the nature andextent of the selling and marketing efforts in relation to the contract value.

Some states have more specific policies regarding selling costs and state that“general sales promotion” costs shall include/encompass any activity conducted bya company that is meant to call attention to or enhance the image of the company,its products and/or services. Any cost associated with such activity shall beunallowable.

Travel Expenses (FAR 31.205.46)Travel expenses, based on their nature and purpose may be allowable as eitherindirect or direct. Travel costs incurred in the normal course of overalladministration of the business are allowable and shall be treated as indirect costs.Travel costs attributable to specific contract performance are allowable and maybe charged to the contract. Costs for transportation may be based on mileage rates,actual costs incurred, or on a combination thereof; costs of lodging, meals andincidental expenses may be based on per diem, actual expenses, or a combinationthereof, provided the method used results in a reasonable charge as provided in theFederal Travel Regulation (FTR).

Costs shall be allowable only if the following information is documented:

• Date and Place

• Purpose of Trip

• Name of personnel or relationship to the contractor

• For transportation costs a log must be maintained

Legal Costs (FAR 31-205-47)Costs incurred in connection with any proceeding brought by a Federal, state orlocal government for violation by the consultant of a law or regulation are oftenunallowable. The FARs provide specific criteria. Costs of legal, accounting, etc.that arise as a result of a dispute between consultants that are partners in a jointventure, or similar shared interest arrangement, are unallowable. This FARssection also requires that these costs, including directly associated costs, which maybe unallowable, be segregated in the accounting system.

Business Combination Costs (FAR 31.205-49 &-52)A business combination occurs when a corporation and one or more incorporatedor unincorporated businesses are brought together into one accounting entity.These combinations are classified as mergers or consolidations and are accounted


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for as purchases or pooling of interests. The purchase method accounts for abusiness combination as the acquisition of one company by another (merger). Anydifference between the cost of an acquired company and the sum of the fair valuesof tangible and identifiable intangible assets less liabilities is recorded as goodwill.

Costs for amortization, expensing, write-off, or write-down of goodwill (howeverrepresented) are unallowable.

When the purchase method is used, allowable costs for amortization, cost ofmoney and depreciation are limited to the amounts that would have been allowedhad the combination not taken place. Consultants must maintain detailed recordswhich identify and track elements of costs for future reporting periods.

Alcoholic Beverages (FAR 31-205-51)Costs of alcoholic beverages are unallowable and consultant’s records shouldclearly segregate these costs and exclude them from the indirect cost schedule.


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Chapter Six - Management’s Responsibility forAccounting RecordsIt is the responsibility of management of companies involved in governmentcontracts to prepare timely, accurate financial statements. In most cases specialschedules and disclosures will be required in addition to normal annual financialstatements, prepared for stockholders, for lending institutions or for internalmanagement.

Schedule of Indirect CostThis schedule is the primary financial statement for determining the indirect costoverhead rate. It will be developed from financial statement and/or general ledgeramounts as well as from amounts in the contractor’s cost accounting system. Thisschedule must be in agreement with or reconciled to financial statement and/orgeneral ledger amounts.

The schedule should clearly display the unallowable amounts that have beenremoved from the indirect expense accounts, or state that the amounts are “net ofunallowable costs.”

Direct labor should be included as a separate line item and must be in agreementwith general ledger and/or project accounting records.

Other items, such as Facilities Capital Cost of Money, may be shown as required byindividual states.

The Schedule of Indirect Costs or accompanying notes should show the calculationof the overhead rate. In some cases multiple overhead rates will be shown such asfunctional rates for segments of the business, or rates for separate subsidiaries.

It should be emphasized the consultant is responsible for accounting for costsappropriately and for maintaining records, including supporting documentation,adequate to demonstrate that costs claimed have been incurred, are allocable to thecontract, and comply with applicable cost principles. Examples of supportingdocumentation include time sheets and usage logs. Costs which are not adequatelysupported may be disallowed all or in part by the auditor. When accountingpractices are inconsistent with the FARs, costs resulting from such practices shall

Chapter

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not be allowed in excess of the amount that would have resulted from thoseconsistent with the FARs.

The consultant is responsible for maintaining consistency in estimating,accumulating and reporting costs. All projects should benefit from the sameaccounting procedures and processes.

UnallowableUnallowable CostsFARs 31.201-6 requires that unallowable costs and any directly associated cost beidentified and excluded from billings, claims or proposals for government contracts.In addition, unallowable costs must participate in indirect cost allocations just asthey would if they were allowable. See Appendix D for a list of commonunallowable costs.

Consultants are to maintain adequate records to establish and maintain thevisibility of identified unallowable costs including directly associated costs. If adirectly associated cost is included in a cost pool that is allocated over a base thatincludes the unallowable cost with which it is associated, the directly associatedcost should remain in the cost pool. In all other cases, the directly associated costs,if material in amount, must be purged from the cost pool as unallowable costs.

Salary expenses for the time employees participate in activities that generateunallowable costs should be treated as directly associated costs provided the costsare material. Time spent by employees outside the normal working hours would notbe considered unless the employee engaged in those company activities sofrequently outside the normal working hours that it would indicate that theactivities are a part of the employee’s regular duties.

Financial StatementsFinancial statements will vary depending on the company ownership, organization,size, etc.. Publicly-held companies will generally have audited financial statementswhich includes the opinion of the CPA firm. Other entities may also have auditedfinancial statements to serve the needs of lending institutions, owners, governmentagencies, etc.

Many smaller firms will have financial statements which are compiled byaccounting firms. In many cases, the accounting firms will also assist in preparingthe Schedule of Indirect Costs.

In some cases, the financial statements will be prepared by internal accounting ormanagement personnel.

In all cases the financial statements should include representations frommanagement that the amounts are timely, accurate and in compliance withregulations that apply to their individual circumstances.


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DisclosuresDisclosures are generally included with financial statements. They would includeexplanatory information about the financial data. Disclosures may describe thetypes of accounting systems and methods. They may describe the types ofoperations or contracts. A schedule of principal owners is often included.

The disclosures should describe if the statements are, or, are not, in compliancewith authoritative pronouncements such as GAAP, FARs, etc.

Extraordinary events that may have a material impact on the financial statementamounts should be disclosed.

Management RepresentationsIn working with consultants it is important for auditors to obtain writtenrepresentations from management personnel. Specific representations will varydepending on the circumstances as well as other available information, such asaudited financial statements. For indirect cost overhead audits, auditors shouldrequest representations such as:

• the financial information is accurate• the financial information is complete• the information is in compliance with government

regulations (i.e. FARs)• estimates are based on sound financial data and consistent

assumptions

In some contract audit environments, a management-certified cost proposal may bethe starting point for the audit and serves as management’s representation. Theauditor should consider obtaining additional representations on matters that ariseduring the course of the audit.


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Chapter Seven - Audit ConsiderationsAudits of consultant indirect cost rates present unique and significant issues thatauditors must consider when planning and performing audits. For detailedinformation and guidance, the reader should refer to the following publications:

• Government Auditing Standards (GAO “Yellow Book”) andGenerally Accepted Auditing Standards

• Audits of Federal Government Contractors (AICPA)

• Consideration of the Internal Control Structure in a FinancialStatement Audit (AICPA)

It must be emphasized that auditors must exercise significant judgment inplanning and performing audits and take into consideration the uniquecircumstances involved with each government contractor and associatedaccounting systems. A wide variety of tools and publications may be helpful indetermining the appropriate audit procedures, testing methods and reportingformats.

Auditors must consider specific government regulations and individual contractprovisions when designing and performing audit procedures.

Internal ControlsManagement is responsible for maintaining an effective internal controlstructure. The unique requirements of cost-based government contracting requirecycles and elements of internal control which must be evaluated as part of an audit.The following important elements must be considered in the auditor’s evaluation ofinternal control on a consulting firm:

• Systems for monitoring compliance with governmentprocurement regulations

• Estimating systems and proposal preparation practices• Contract cost accounting practices

− Systems for tracking and allocating labor cost

− Systems for allocating non-labor direct costs

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− Systems for allocating costs through cost centers• Billing procedures and controls• Miscellaneous Revenues/Credits• Change order identification, pricing, and reporting• Cost aspects of related-party and interorganizational

transactions

Compliance with government procurement regulations is an important aspectfor government contractors. Examples include compliance with Cost AccountingStandards (CAS) and Federal Acquisition Regulations (FARs). Controls must be inplace that are designed to provide reasonable assurance of compliance withapplicable regulations. Management must ensure that employees are made aware ofcompliance policies and that procedures are carried out and updated as regulationschange.

Controls over estimating systems and preparation of proposals are importantso that management’s risk of loss when signing a contract is minimized. Thecontrols ensure that reliable cost estimates support contract proposals, that the costdata are accurate, current and complete, that the source of cost data is welldocumented. The estimating process should be consistent and written policies andprocedures should be maintained.

Contract cost accounting practices and systems are critical for governmentcontracting. Well-controlled systems ensure that costs are distributed to costobjectives accurately and form a basis for comparing actual costs with estimatedcosts. Maintaining adequate controls provides reasonable assurance that:

• Costs are accurately distributed to cost objectives• Costs are reasonable and in accordance with contract

provisions• Unallowable costs are segregated• Cost-allocation practices are reasonable and in conformity

with applicable CAS/GAAP• Costs incurred on all projects are periodically reconciled to

financial statements

Accounting for labor accurately is paramount to accurate cost-based accounting.Detailed records must be maintained, accumulated and controlled to ensure thatboth the direct labor and indirect labor amounts are accurate. Procedures mustbe in place to ensure that direct labor charges are distributed to respectivecontracts. Indirect labor must be captured and assigned to appropriate indirectlabor categories. The total of direct labor plus the indirect labor displayed in thegeneral ledger must reconcile to the overall labor recorded in the payroll system forthe period.

Other areas where management must devote significant attention include:Disbursements/Expenditures, Allocations of Other Direct Costs, Billing


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Procedures, Related Party Transactions and Interorganizational Transfers.Systems must be in place to ensure accurate recording of transactions. Controlsmust exist to insure that entries are reviewed and approved and that errors arepromptly corrected. Management must maintain records to support thetransactions and provide for an audit trail. Where integrated accounting systemsare in place, management must have procedures to ensure that transactions areaccurately recorded, summarized and transferred through the systems.

Understanding the Consultant’s BusinessThe auditor should obtain an understanding of the consultant’s business. Thefollowing are examples of categories of information that may be obtained, asappropriate, and considered by the auditor in planning the engagement:

• The consultant’s products and services, including therelationship of those products and services to cost-basedgovernment contracts

• The nature, size, and location of the consultant’s operations• Mix of government and commercial business• Competition in the industry• Types of contracts (lump sum, cost plus fixed fee, time &

materials)• The consultant’s accounting policies and procedures• Key data for significant contracts including the following:

• Government Agency or Department• Type of Contract• Contract Price• Revenues, costs and profit/loss recognized to date• Incentive, escalation, or other relevant contract

provisions• Government Regulations affecting contract accounting such

as state cost principles• Key changes in operations, systems or segments of the

business• CAS Disclosure Statement and Revisions if applicable• Key information-processing systems• Related party and interorganizational transactions• Litigation, claims and disputes• Prior audited indirect cost rates• Prior filings with the SEC such as Form 10-K• Minutes of the meetings of the board of directors• Federal & State income tax returns•

Consideration of Other Financial and Contract AuditsInformation may be obtained from the contractor pertaining to other audits. Thesemay include Audited Financial Statements (by CPA firm), audits by other SHAs,audits by local government agencies, audits by federal government agencies (i. e.


7—47—4

Defense Contract Audit Agency), or financial statement compilations/reviews byCPA firms.

Electronic Data ProcessingThe use of computers in the business environment is commonplace and is dynamicand rapidly changing. Therefore, the auditor must carefully assess the impact onthe control environment. Accounting records may be maintained on a wide rangeof equipment including large host-based systems, networked environments, stand-alone PC applications and in some cases outside vendors (i.e. payroll services).The use of the Internet is now common for transmitting data or for accessingregulations and other information involved in government contracting.

The auditor must apply the same standards for controls in highly automated ormanual systems. However, the audit tests may vary significantly depending on thelevel of automation and integration of the systems. In certain instances auditorsmay need to employ experts to properly assess the internal controls. Particularattention should be focused on the contractor’s internal controls as new automatedaccounting systems are implemented or significant upgrades are performed on oldsystems. Contractor personnel must be adequately trained on new systems and beknowledgeable of the impact of control procedures.

Audit Risk and MaterialityAudit risk involves the possibility that the auditor’s testing and review may notdetect material misstatements, mischargings or violations of governmentregulations. If the auditor’s assessment of internal control risk is low, he/she maydecide to accept a higher level of “detection risk” by limiting the audit procedures.When the internal control risk is considered to be high, the auditor will perform agreater amount of testing in order to reduce the detection risk.

When making risk assessments, auditors must consider materiality. This is a highlyjudgmental area but auditors are able to set reasonable levels of risk based onsetting levels of materiality. GAGAS 4.8 states:

“Auditors’ consideration of materiality is a matter of professionaljudgment and is influenced by their perception of the needs of areasonable person who will rely on the financial statements.”

Persons who rely on consultant indirect cost rates often expect a greater degree ofaccuracy than users of general purpose financial statements. GAGAS 4.9 pointsout that audits of entities receiving government assistance may require lowermateriality levels than normally found in the private sector because of the publicaccountability of the auditee, the various legal and regulatory requirements, and thevisibility and sensitivity of government programs, activities, and functions.

Type and Volume of ContractsThe level of risk to a consultant varies depending on the type of contract (i.e. fixed-price-type or cost-type contracts). The audit emphasis changes depending on the


7—57—5

types of contracts or the mix of contract types. If the consultant has primarilyfixed-price (lump sum) contracts, the auditor would place more emphasis on thecontractor’s estimating procedures as well as those controls which are designed toensure that all direct costs are excluded from indirect costs. If the consultant hasprimarily cost-type contracts the emphasis would be on allowability anddetermination that costs recorded are not in excess of specific contract limitations.Consultants with a mix of fixed price and cost type contracts require specialemphasis on consistent allocation of costs regardless of whether contract revenuesare based on cost incurred.

The relationship of a consultant’s cost based government contracts to totalcontracts may have several impacts on the audit. Not only does this relationshipimpact the auditor’s assessment of audit risk through materiality, the level of costbased contracts may have a significant impact on the control environment andmanagement’s commitment to internal control aspects unique to governmentcontracting.


8—18—1

Chapter Eight - Audit ProceduresGeneralThe following guidelines should be considered when developing specific auditprocedures for consultant overhead rate audits.

Labor CostsIn the majority of consultant contracts labor is the largest single component of cost.This component is made up of direct labor charges to the contract and indirectlabor charges allocated to the contract through a factor or rate.

Verification of labor costs begins with the examination of the internal controlstructure and testing of those controls as discussed in Chapter 7. Once thisassessment has been made the auditor can determine the size and depth of theaudit sample for labor testing.

1. The labor sample should be tracked from employee time records to:

• The payroll records to assure hours recorded are paid.• The cost system to assure hours are posted properly to jobs.• The general ledger to assure that the total posted is recorded

in the financial accounting system.2. The overall labor in general ledger accounts should be reconciled to:

• The job cost system• The payroll reports submitted to the Internal Revenue

Service (i.e. 941’s).3. Audit procedures should also determine if the labor accounts and

individual time card entries sufficiently screen labor to:

• Determine the allowability of payroll cost. (i.e. Do therecords separate excess compensation and time spent onunallowable activities?)

• Determine the proper allocation of labor. (i.e. Do the recordscharge all labor performed on similar tasks the same way?)

• Determine if labor is posted in a manner from which thelabor base can be computed. (i.e. If the base is direct labor

Chapter

8


8—28—2

without premium overtime do the records accumulate directlabor and direct premium overtime?)

Allocated CostsCost centers are developed to capture costs associated with a single purpose. Thecosts are assigned to objectives based on unit charges. Examples of categories forindividual cost centers are printing, computers and vehicles. The over/underallocation of costs is usually handled as an adjustment to the overhead pool, whichis where the cost would have been charged if it had not been directed to the costcenter. If the over/under allocation is significant, consideration should be given toadjusting the contract charges.

Some accounting systems will attempt to adjust the unit charge rate for theover/under allocation of the cost centers. The goal of any cost center is tominimize the over/under allocation by the application of a properly estimated unitcharge.

Audit issues of particular concern are:

1. Costs posted to the center are properly allocable. Do the costs belongto the function being priced?

2. Costs posted to the center are allowable. Do the costs exclude interest,profit or other costs excluded under the FARs?

3. The unit charge records indicate the consistent assignment of allsimilar charges to projects.

Item three is the one most often overlooked by firms and can result in substantialadjustments.

Some firms do not choose to set up cost centers. These firms estimate the cost ofproviding certain services by pulling just certain elements from ledger accounts (i.e.automobile depreciation from a general ledger depreciation account). Onceestablished, these unit charges are offset to overhead as they are utilized onprojects. This type of costing is less precise and should not be utilized if the unitcharges being accumulated are significant to the firm’s overall operation.

Other Direct CostsInvoices received from vendors or employees support these costs. They areprocessed through the cost accounting system and assigned directly to a project.The costs are not included in the overhead pool. Direct accounts should beestablished in the General Ledger and all similar costs should be posted to theaccounts. Some examples are: project travel, vendor printing, employee mileage,rented vehicles and equipment, and subcontracts.

The audit procedures for these costs concentrate in two areas. The first area is thedirect cost accounts themselves. The procedures are:


8—38—3

• Determine if costs are posted to the proper account and assigned tothe correct projects.

• Determine if the costs are allowable in accordance with thecontract and FARs.

The second area would concentrate on the overhead accounts. The accounts testedwould be the ones similar in nature of cost to those charged to the direct accounts.The main audit efforts should be concentrated on:

• Determine if costs are consistently allocated to projects when theyare incurred for similar purposes.

• Determine if costs are priced consistently to direct and indirect costobjectives.

Other Audit ProceduresSpecific additional audit procedures are dependent upon the individual firm beingaudited. Certain audit steps that may be required for one firm are not necessary foranother.

Several of these areas can be identified by a comprehensive preliminary review ofthe following information:

1. A detailed overhead rate schedule is needed to assure the auditeehas separated unallowable costs as required by FARs.

2. An accounting and control survey is needed which will answerquestions about possible areas of concern. Examples are:

• Gains or losses on assets• Personal use of autos• Transactions with common control entities• Bonus plans• Direct costing policies• Acquisitions and re-structuring• Depreciation schedules

3. A tax return prepared for the fiscal year(s) being audited. Manyareas addressed in the return are of concern to the Internal RevenueService as well as for government contracting.

4. A disclosure statement (required by Cost Accounting Standards)when federal contracts exceed a given amount as follows:

- $25 million per single contract, or

- $25 million in CAS-covered contracts with atleast one single award exceeding $1 million


9 - 19 - 1

Chapter Nine - Reporting & Report DisclosuresAudit reports may take a variety of formats and styles. When performing indirectcost audits, the auditor shall prepare a Report on the Statement of IndirectCosts and a Report on Internal Controls. The following represent samples ofthese reports we recommend for use by state transportation departmentauditors and public accounting firms when performing indirect cost audits ofengineering consulting firms.

The American Association of State Highway and Transportation Officials(AASHTO) Audit Subcommittee and the American Council of EngineeringCompanies (ACEC) Transportation Committee have prepared and approved for usethe following indirect cost rate audit report format for engineering consulting firms.The uniform use of this report format by state highway and transportationdepartment auditors and public accounting firms will greatly enhance theunderstanding and utility of these reports when distributed to the consulting firmsand the federal, state and local agencies who contract for their professionalservices.

It is important for the auditor to understand that each indirect cost audit must beconducted in accordance with Generally Accepted Auditing Standards and thefinancial audit standards contained in the Government Auditing Standards issuedby the Comptroller General of the United States of America. Also, the schedule ofindirect costs must be prepared in accordance with the accounting principlesprescribed in Part 31 of the Federal Acquisition Regulations.

Chapter

9


9 - 29 - 2

Report on Schedule of Indirect CostsINDEPENDENT AUDITOR’S REPORT ON THE SCHEDULE OF INDIRECT COSTS

Board of DirectorsThe Company

We have audited the Schedule of Indirect Costs for the fiscal year ended December 31, 1999. This statement isthe responsibility of the Company’s management. Our responsibility is to express an opinion on this statementbased on our audit.We conducted our audit in accordance with generally accepted auditing standards and the financial audit standardscontained in the Government Auditing Standards issued by the Comptroller General of the United States ofAmerica. Those standards require that we plan and perform the audit to obtain reasonable assurance aboutwhether the statement is free of material misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the Schedule of Indirect Costs. An audit also includes assessing theaccounting principles used and significant estimates made by management, as well as evaluating the overallstatement presentation. We believe that our audit provides a reasonable basis for our opinion.The accompanying statement was prepared on a basis of accounting practices prescribed by Part 31 of the FederalAcquisition Regulations (FARs) and certain other federal and state regulations as discussed in Note 2, and is notintended to be a presentation in conformity with generally accepted accounting principles.In our opinion, the statement referred to above presents fairly, in all material respects, the direct labor, fringebenefits and general overhead of the Company for the year ended December 31, 1999 on the basis of accountingdescribed in Note 2.In accordance with the Government Auditing Standards we have issued a report dated April 4, 2000 on ourconsideration of the Company’s internal controls and its compliance with laws and regulations.This report is intended solely for the use and information of the Company and government agencies or othercustomers related to contracts employing the cost principles of the Federal Acquisition Regulations and should notbe used for any other purpose.

Bob Brooks, CPA, DirectorExternal Audit Branch

April 4, 2000


9 - 39 - 3

Report on Internal Control: No Reportable ConditionsINDEPENDENT AUDITOR’S REPORT ON INTERNAL CONTROLS


We have audited the Schedule of Indirect Costs of the Company for the fiscal year ended December 31, 199x, andhave issued our report thereon dated April 4, 2000. We conducted our audit in accordance with generally acceptedauditing standards and the financial audit standards contained in the Government Auditing Standards issued by theComptroller General of the United States of America.

Compliance

As part of obtaining reasonable assurance about whether the Company’s schedule is free from materialmisstatement, we performed tests of the Company’s compliance with certain provisions of laws, regulations andcontracts, including the provisions of the applicable sections of Part 31 of the Federal Acquisition Regulations,noncompliance with which could have a direct and material effect on the determination of the schedule amounts.However, providing an opinion on compliance with those provisions was not an objective of our audit and,accordingly, we do not express such an opinion. The results of our tests disclosed no instances of noncompliancethat are required to be reported under Government Auditing Standards.

Internal Control Over Financial Reporting

In planning and performing our audit, we considered the Company’s internal control over financial reporting inorder to determine our auditing procedures for the purpose of expressing an opinion on the schedule and not toprovide assurance on internal control over financial reporting. The management of the Company is responsible for establishing and maintaining internal control over financialreporting. In fulfilling this responsibility, estimates and judgments by management are required to assess theexpected benefits and related costs of internal control over financial reporting. The objectives of internal controlover financial reporting are to provide management with reasonable, but not absolute, assurance that assets aresafeguarded against loss from unauthorized use or disposition, and that transactions are executed in accordancewith the Federal Acquisition Regulations Part 31. Because of inherent limitations in any internal controlstructure, errors or irregularities may nevertheless occur and not be detected. Also, projection of any evaluationof the structure to future periods is subject to the risk that procedures may become inadequate because of changesin conditions or that the effectiveness of the design and operation of policies and procedures may deteriorate.For the purpose of this report, we have classified the significant internal controls over financial reporting in thefollowing categories: cash disbursements and payroll.Our consideration of the internal control over financial reporting would not necessarily disclose all matters in theinternal control over financial reporting that might be material weaknesses. A material weakness is a condition inwhich the design or operation of one or more of the internal control components does not reduce to a relativelylow level the risk that misstatements in amounts that would be material in relation to the financial statementsbeing audited may occur and not be detected within a timely period by employees in the normal course ofperforming their assigned functions. We noted no matters involving the internal controls over financial reportingand its operation that we consider to be material weaknesses.This report is intended solely for the use and information of the Company and government agencies or othercustomers related to contracts employing the cost principles of the Federal Acquisition Regulations, and shouldnot be used for any other purpose.


April 4, 2000


9 - 49 - 4

Report on Internal Control: With Reportable ConditionsWhich are Material WeaknessesINDEPENDENT AUDITOR’S REPORT ON INTERNAL CONTROLS



Compliance



In planning and performing our audit, we considered the Company’s internal control over financial reporting inorder to determine our auditing procedures for the purpose of expressing an opinion on the schedule and not toprovide assurance on internal control over financial reporting. The management of the Company is responsible for establishing and maintaining internal control over financialreporting. In fulfilling this responsibility, estimates and judgments by management are required to assess theexpected benefits and related costs of internal control over financial reporting. The objectives of internal controlover financial reporting are to provide management with reasonable, but not absolute, assurance that assets aresafeguarded against loss from unauthorized use or disposition, and that transactions are executed in accordancewith the Federal Acquisition Regulations Part 31. Because of inherent limitations in any internal controlstructure, errors or irregularities may nevertheless occur and not be detected. Also, projection of any evaluationof the structure to future periods is subject to the risk that procedures may become inadequate because of changesin conditions or that the effectiveness of the design and operation of policies and procedures may deteriorate.For the purpose of this report, we have classified the significant internal controls over financial reporting in thefollowing categories: cash disbursements and payroll.Our consideration of the internal control over financial reporting would not necessarily disclose all matters in theinternal control over financial reporting that might be material weaknesses. A material weakness is a condition inwhich the design or operation of one or more of the internal control components does not reduce to a relativelylow level the risk that misstatements in amounts that would be material in relation to the financial statementsbeing audited may occur and not be detected within a timely period by employees in the normal course ofperforming their assigned functions. Our study and evaluation disclosed the following condition in the system ofinternal accounting control of the Company, which we consider to be a material weakness as defined above.

[Describe the condition]

This report is intended solely for the use and information of the Company and government agencies or othercustomers related to contracts employing the cost principles of the Federal Acquisition Regulations.



9 - 59 - 5

E X A M P L E : M A T E R I A L W E A K N E S S E S

Note: This page is added to the introductory page of the report to describethe conditions that lead to the material weaknesses.

Accounting Records and Financial Statements:Accounting records are not closed out and reconciled on a regular basis. The Consultant’s accounting packagecontains few Internal Controls. Record-keeping errors have gone undetected because of a lack of oversightreviews of accounting activities. Financial statements are not prepared on a periodic basis during the year and aregenerally not prepared by the outside accounting firm until September of the following year. The consultant doesnot prepare a Schedule of Indirect Costs in accordance with FARs part 31.

The result of these deficiencies is accounting records which may be inaccurate. They do not form a sound basisfor timely preparation of the Schedule of Indirect Costs and the resultant overhead rate calculation.

Recording of Job Costs and Direct Labor:Direct costs are posted manually to the Transaction Report, the Job Cost System, and the Billing Invoice.Differences, which went undetected, were noted between the three reports.

Labor is not distributed in the accounting system between direct and indirect classifications. The hours worked inexcess of 40 hours per week by salaried employees are not recorded in the Transaction Report yet they arecharged to the project. Therefore, the labor dollars per the job cost system do not agree with the financialrecords.

The above deficiencies relating to job costs and direct labor can lead to inaccurate invoicing. Incorrect directlabor and indirect labor amounts may be used in determining the overhead rate.

A material weakness is a reportable condition in which the design or operation of the specific internal controlstructure elements does not reduce to a relatively low level the risk that errors or irregularities in amounts thatwould be material in relation to the schedule being audited may occur and not be detected within a timely period byemployees in the normal course of performing their assigned functions.

Our consideration of the internal control structure would not necessarily disclose all matters in the internalcontrol structure that might be reportable conditions and, accordingly, would not necessarily disclose all reportableconditions that are also considered to be material weaknesses as defined above. We believe the reportableconditions described above, taken in the aggregate, constitute a material weakness.

This report is intended solely for the use and information of government agencies as related to contractsemploying the cost principles of the FARs, modified as required by applicable regulations.

Bob Brooks

Chief of AuditDecember 1, 1998

Dennis R Payne

Dennis R Payne


9 - 69 - 6

Report on Internal Control: With Reportable ConditionsWhich are Not Material WeaknessesINDEPENDENT AUDITOR’S REPORT ON INTERNAL CONTROLS



Compliance



In planning and performing our audit, we considered the Company’s internal control over financial reporting inorder to determine our auditing procedures for the purpose of expressing an opinion on the schedule and not toprovide assurance on internal control over financial reporting. The management of the Company is responsible for establishing and maintaining internal control over financialreporting. In fulfilling this responsibility, estimates and judgments by management are required to assess theexpected benefits and related costs of internal control over financial reporting. The objectives of internal controlover financial reporting are to provide management with reasonable, but not absolute, assurance that assets aresafeguarded against loss from unauthorized use or disposition, and that transactions are executed in accordancewith the Federal Acquisition Regulations Part 31. Because of inherent limitations in any internal controlstructure, errors or irregularities may nevertheless occur and not be detected. Also, projection of any evaluationof the structure to future periods is subject to the risk that procedures may become inadequate because of changesin conditions or that the effectiveness of the design and operation of policies and procedures may deteriorate.For the purpose of this report, we have classified the significant internal controls over financial reporting in thefollowing categories: cash disbursements and payroll.We noted certain matters involving the internal control over financial reporting that we consider to be reportableconditions under standards established by the American Institute of Certified Public Accountants. Reportableconditions involve matters coming to our attention relating to significant deficiencies in the design or operationof the internal control over financial reporting that, in our judgment, could adversely affect the organization’sability to record, process, summarize and report financial data in a manner that is consistent with the assertions ofmanagement in the statement.Our consideration of the internal control over financial reporting would not necessarily disclose all matters in theinternal control over financial reporting that might be material weaknesses. A material weakness is a condition inwhich the design or operation of one or more of the internal control components does not reduce to a relativelylow level the risk that misstatements in amounts that would be material in relation to the financial statementsbeing audited may occur and not be detected within a timely period by employees in the normal course ofperforming their assigned functions. We believe none of the reportable conditions described above are a materialweakness.

[Describe the condition/s]

This report is intended solely for the use and information of the Company and government agencies or othercustomers related to contracts employing the cost principles of the Federal Acquisition Regulations, and shouldnot be used for any other purpose.

Bob Brooks, CPA, Director External Audit Branch April 4, 2000


9 - 79 - 7

E X A M P L E S : R E P O R T A B L E C O N D I T I O N S

We noted matters involving the internal control structure and its operation that we consider to be reportableconditions under standards established by the American Institute of Certified Public Accountants. Reportableconditions involve matters coming to our attention relating to significant deficiencies in the design or operationof the internal control structure that, in our judgment, could adversely affect the entity's ability to record, process,summarize, and report financial data consistent with the assertions of management in the schedule of indirectcosts.

Segregating Costs

The Federal Acquisition Regulations (FARs) require that any cost that can be identified specifically witha final cost objective should be recorded as a direct cost of that cost objective. The FARs further statethat an indirect cost is any cost not directly identified with a single, final cost objective, but identifiedwith two or more final cost objectives.

Sample Engineering, Inc. didn’t identify, accumulate, and distribute direct and indirect expenses inaccordance with the FARs. Direct costs weren’t segregated from indirect costs. We recommend thatthe Company utilize an account structure to adequately segregate direct and indirect costs in order to bein compliance with the FARs.

Job Cost System & Managerial Commitment

The job cost system was not used in the preparation of invoices because the information in the systemwas not complete. Invoices were manually prepared because the system did not contain information onthe drilling supplies or prices for the direct supplies.

The Company’s management indicated that too much of the project manager’s time was consumed inmaintaining the accounting system. Therefore, the Company is in the process of converting to a newaccounting system, with the belief that the new system will enable the Company to comply with theFARs.

Implementing the new system with appropriate controls and reports will require substantial effort. Atthe present time, it appears that sufficient resources and management support have not been dedicatedto implementing the new system.

Overhead Rate Proposals

The Company has not prepared an overhead rate proposal in compliance with the FARs. At this time,the conditions mentioned above have contributed greatly to the inability to produce an accurateproposal report containing expense adjustments that comply with the FARs. Contracts with DOTrequire that a consultant maintain adequate financial information to properly invoice for actual costs.Without a proposal, the company can’t attest to the validity of the invoiced costs.

REPORTING OF UNALLOWABLE COSTS:A number of transactions, for types of costs considered to be unallowable for years, were found interspersedthroughout the indirect expense accounts. This resulted in increased testing to determine if individual transactionsin accounts contained unallowable transactions unrelated to the accounts in which they had been recorded.According to FAR 31.201-2 and 6, “...the company is responsible for identifying and excluding all unallowable costsfrom the proposal applicable to a Government Contract. The contractor is also responsible for accounting for costsappropriately and for maintaining records, including support documentation, adequate to demonstrate that costsclaimed have been incurred and are allocable to the contract, and comply with applicable cost principles...”

RELATED PARTY TRANSACTIONS:Until September of 1997, the firm had been leasing equipment from a related party (Ajax Leasing Company) whichrequired a yearly adjustment be made reducing the amount charged to the actual cost for use of these assets. At theend of the lease, Sample Engineering, Inc. acquired these assets. Since the assets are already fully depreciated throughpast audit adjustments, further depreciation is not allowed. The firm needs to establish a policy for recognizing andrecording capital versus operating leases.


9 - 89 - 8

Schedule of Indirect CostsThe following sample Schedule of Indirect Costs including the FAR references and descriptions on page 9-9 and thenotes to the Schedule of Indirect Costs on page 9-10 are recommended for use by state transportation departmentauditors and public accounting firms when performing indirect cost audits of engineering consulting firms.

Example:Sample Engineering, Inc.Schedule of Indirect Costs

For the Year Ended December 31, 1999

UNALLOWABLE FAR % DIRECTDESCRIPTION PROPOSED COSTS REFERENCE AUDITED LABOR

DIRECT LABOR 1,039,290$ 3,245$ (1) 31.202 1,042,535$

FRINGE BENEFITSUnemployment Taxes 13,328$ 13,328$ FICA Taxes 120,694 120,694 Bonuses 30,209 (6,625) (2) 31.202/31.205-6(f) 23,584 Health & Dental Insurance 101,246 101,246 401k Expense 28,702 - 28,702

TOTAL FRINGE BENEFITS 294,179$ (6,625)$ 287,554$

GENERAL OVERHEADIndirect Labor 676,825$ 1,179$ (3) 31.202/31.203 678,004$ Utilities 52,836 52,836 Vehicle Expenses 36,405 36,405 Legal & Accounting 20,101 (7,762) (4) 31.205-27(a) 12,339 Office Supplies 41,624 41,624 Repairs & Maintenance 9,511 9,511 Equipment Lease (3,002) (3,002) Dues & Subscriptions 10,256 (398) (5) 31.205-14 9,858 Travel 2,910 2,910 Shipping & Postage 13,269 13,269 Payroll Charges 1,838 1,838 Rent 136,939 (18,000) (6) Rel. Party Trans. 118,939 Licenses & Permits 5,280 5,280 Depreciation 60,114 (3,802) (7) 31.202/31.205-49 56,312 Outside Services 361,553 (300,019) (8) 31.202 61,534 Insurance 83,651 83,651 Education 6,346 6,346 Business Meetings 6,396 6,396 Environmental & Survey Sup. 22,419 22,419 Vehicle Lease 55,068 55,068 Courthouse Expense 5,750 5,750 Printing Expense 8,593 8,593 Taxes 32,439 - 32,439

TOTAL GENERAL OVERHEAD 1,647,121$ (328,802)$ 1,318,319$

TOTAL INDIRECT COSTS 1,941,300$ (335,427)$ 1,605,873$ 154.04%

FACILITIES CAPITAL COST OF MONEY 13,376$ -$ 13,376$ 1.28%

Note: In the event that the consultant uses multiple rates, such as separate fieldoffice rates, they must be disclosed in the Schedule of Indirect Costs. Also,complete explanations of audit adjustments and their associated FAR referencesmust be attached to the Schedule of Indirect Costs.


9 - 99 - 9

Criteria Description for FAR References and Other AuditAdjustments

( 1 ) 3 1 . 2 0 2

L a b o r c o s t s i d e n t i f i e d s p e c i f i c a l l y w i t h a c o n t r a c ta r e d i r e c t c o s t s o f t h e c o n t r a c t .

( 2 ) 31 .202 /31 .205 -6 ( f )

B o n u s e s s p e c i f i c a l l y r e l a t e d t o a p r o j e c t a r ed i r e c t . / B o n u s e s a r e a l l o w a b l e i f p a i d a c c o r d i n g t o a ne x i s t i n g p l a n o r c o n s i s t e n t p o l i c y .

( 3 ) 3 1 . 2 0 2 / 3 1 . 2 0 3L a b o r c o s t s i d e n t i f i e d s p e c i f i c a l l y w i t h a c o n t r a c t a r ed i r e c t c o s t s o f t h e c o n t r a c t . I n d i r e c t l a b o r c o s t s a r et h o s e i d e n t i f i e d i n t h e t w o o r m o r e c o s t o b j e c t i v e s .

( 4 ) 31 .205 -27 (a )

L e g a l c o s t s a s s o c i a t e d w i t h a r e o r g a n i z a t i o n a r eu n a l l o w a b l e .

( 5 ) 31 .205 -14

D u e s a s s o c i a t e d w i t h s o c i a l , d i n i n g o r c o u n t r y c l u b sa r e u n a l l o w a b l e .

( 6 ) R e l a t e d P a r t y T r a n s a c t i o n – S e e N o t e 5 o n p a g e 1 0 .

( 7 ) 3 1 . 2 0 2 / 3 1 . 2 0 5 - 4 9

D e p r e c i a t i o n o n c o s t s c h a r g e d t o a s p e c i f i c c o n t r a c ta r e d i r e c t . / A m o r t i z a t i o n o f g o o d w i l l i s u n a l l o w a b l e .

( 8 ) 3 1 . 2 0 2

C o n t r a c t u a l s e r v i c e s c h a r g e d t o a c o n t r a c t a r e d i r e c tc o s t s .


9 -109 -10

Notes to the Schedule of Indirect CostsSample Engineering, Inc.

Notes to Schedule of Indirect CostsFor the Year Ended December 31, 1999

( 1 ) P r inc ipa l Bus iness Act iv i ty

Sample Engineering, Inc. (the Company) was incorporated in 1994. The Companyprimarily provides engineering, survey, and construction management servicesto both the public and private sector.

( 2 ) Bas i s o f Account ing

The Company's indirect cost schedule was prepared on the basis of accountingpractices prescribed in Part 31 of the Federal Acquisition Regulations (FARs).Accordingly, the schedule of indirect costs is not intended to present the resultsof operations of the Company in conformity with generally accepted accountingprinciples.

( 3 ) D is t r i bu t ion o f D i rec t Lab o r C o s t s

The Company distributes labor costs to direct projects for all employeeclassifications. Overtime premium costs are distributed directly to projects whenapplicable.

( 4 ) D i rec t Cos ts

The schedule excludes the following classifications of costs which were relatedto projects:

• Automobiles• CADD charges

Subcontracts:The source of the direct charge is the vendor invoice received by the Consultant.

( 5 ) Re la ted Pa r ty T ransact ions

The firm incurred rental costs through the rental of a facility from a related partyunder common control. Common control is determined to exist when:• The combined direct or indirect ownership of individual shareholders

common to each entity equals 50% or more in each entity, or• One entity leases property from another and either entity has 50% or more

ownership in the other.Allowable rental charges between any divisions, subsidiaries, or organizationsunder common control are limited to the actual costs of ownership as per theSHA guidelines. Any adjustment reflects the difference between the rents paidand the actual costs of ownership.


9 -119 -11

Recommended Report Disclosures

The examples are for illustrative and explanatory purposes only. They are notintended to be all-inclusive regarding every rule and regulation, nor appropriate toevery situation for every consultant. Disclosures should be included with theIndirect Cost Audit for each fiscal year. Disclosures may be included in the Notesto the Schedule of Indirect Costs or as a separate section within the report.

DISCLOSURE NOTES AND EXAMPLES1. DESCRIPTION OF THE COMPANY AND ITS ACCOUNTINGPOLICIES

Describe the consultant’s financial accounting system (cash, accrual,hybrid, etc.) and job cost accounting system (job order, modified joborder, standard, hybrid). Include a description of accounting policiesand procedures governing the classification of costs as direct orindirect.

A schedule of indirect costs (see previous example on page 9-8) andoverhead rate(s) computation should be included in the disclosurerequirements package. A schedule should identify all indirect costpools as well as allocation bases for the overhead rate(s). Thedisclosure package should:

• Identify the Reporting Unit: company wide, businesssegment, technical specialty (design, constructionadministration, geotechnical, environmental, etc.), and/orgeographical location pertaining to the overhead rate(s).

• Identify that Other Direct Costs (ODC) are consistentlycharged to all projects, and not just projects that reimbursefor ODCs (i.e. computer costs, reproduction, equipmentcharges and vehicle usage). Include an evaluation of thepropriety and consistency of recording such costs in theaccounting records.

• Describe how the company charges labor to all projects (i.e.actual, average, or standard hourly rates).

• Describe how and when variances are recorded if using otherthan actual labor costs.

• Explain the company’s policy and accounting practice as topaid vacation, sick leave and comp time.


9 -129 -12

E X A M P L E S :

DESCRIPTION OF THE COMPANY AND ITS ACCOUNTINGPOLICIES

The Company’s principal business activities are consultingengineering services. The Company maintains its accounting recordson the accrual basis for financial reporting, while using the cashmethod of accounting for income tax purposes. The attached auditedSchedule of Indirect Cost Pools has been prepared on the accrualbasis. The Company is organized under Subchapter S of the InternalRevenue Code, wherein all income and expense items are passedthrough to shareholders and reported on their respective individualincome tax returns.

The Company has 10 offices in three states, with approximately 500employees. It engages primarily in civil engineering (highway design)and environmental studies.

The audited overhead rate is a unitary rate for all offices and bothdisciplines. Direct project costs and allocated indirect costs areincluded in project cost records.

The Company has a job order cost accounting system.

The allocation basis for indirect costs is direct labor. Direct labor ofsalaried employees is calculated using their standard hourly rate(annual salary/2080 hrs).

In-house costs such as computers, CADD, equipment, computersoftware programs, and corporate vehicles are included in the firm’soverhead rate.

The Company has separate expense accounts for sub-consultants,personal vehicle mileage, and reproduction costs that are project-related. The Company maintains logs documenting direct projectusage of certain reproduction costs. These costs are charged at thefollowing firm-wide standard rates:

(Provide a list of firm-wide standard rates.)

Using these rates, the Company records direct usage costs by firstcharging the project, then crediting the indirect cost pool. Thesecharges are consistently made to all projects, regardless of whether ornot they are billed to the client. However, the above charges are notbased on a detailed cost study, are not accumulated in a manner thatallows the calculation of variances from actual cost, and the Companymakes no periodic adjustments in the rates.


9 -139 -13

2. LABOR RELATED COSTSPAID OVERTIME AND UNCOMPENSATED OVERTIME

Indicate where the premium portion of overtime pay is recorded in thecost accounting system. Detail the consultant’s procedures forrecording uncompensated overtime incurred by employees chargingdirect project time. Provide an assessment of the materiality of anysuch uncompensated overtime.

E X A M P L E S :

PAID OVERTIME

Overtime costs are incurred in meeting certain deadlines. If anemployee is eligible for overtime, they have their choice of a cashpayment equal to time and a half (premium portion), or compensatorytime off at time and a half. The premium portion of paid overtime isincluded in the indirect cost pool.

UNCOMPENSATED OVERTIME

The Company did not pay certain salaried employees for time workedin excess of 40 hours per week. The time in excess of 40 hours wascredited to the indirect cost pool. The credited amount ($xx,xxx)consisted of hours worked in excess of 40, times the employee’sstandard hourly rate.

HIGHLY COMPENSATED EMPLOYEES/OFFICERS

FAR §31.205-6(p) sets a specific dollar limit on the compensation[total compensation as defined in FAR §31.205-6(a)] of “seniorexecutives The reasonable compensation limit or range that was usedby the auditor should be disclosed in the notes to the audit report.Note: Due to confidentiality, detailed salary amounts should notbe disclosed in the report but may be requested.

E X A M P L E :

The Company paid compensation to senior executives in excess of theFAR §31.205-6(p) limit of $342,986 per person. The total, which wasadjusted to the Schedule of Indirect Cost Pools, amounted to$XXX,XXX.


9 -149 -14

PENSION FUND/DEFERRED COMPENSATION

If pension and/or deferred compensation costs (as defined by FARs§31.205-6(j) and §31.205-6(k) respectively) are included in indirectcosts, identify whether the plan(s) meet the above regulations andexplain how the costs were determined (e.g. - cash contribution, stockor options to purchase stock of the consultant, assets other than cash).In regard to Employee Stock Option Purchase (ESOP) plans, identifythe dollar amounts of principal, interest, and administrative costs of thecontribution to the Employee Stock Option Trust (ESOT).

E X A M P L E :

The Company has a 401(k) pension plan, meeting the requirements ofFARs §31.205-6(j), to which it makes a cash contribution of 2% ofemployee salary per year.

In addition, the Company has a leveraged deferred compensationESOP started in 1984. The plan provides for cash payments of theappraised value of the stock (held by the ESOT for the employee) uponretirement, leaving the Company after 10 years service, or death.Since CAS 9904.415(a)(3) has not been satisfied, the Companyassigns the payments to the period in which the compensation is paidto the employee.

UNCOMPENSATED SICK LEAVE

Provide the consultant’s policy as to accounting for accrued sick leaveupon termination. (Note – there might be a disclosure even thoughthere is no adjustment).

E X A M P L E :

The Company incorrectly accrued sick leave costs that were earnedduring the period, and included them in the overhead rate. However,because sick leave is not paid to an employee upon termination,$X,XXX of this cost was eliminated from the indirect cost pool.


9 -159 -15

CONTRACT LABOR

Provide the methodology used by the consultant to account forcontract labor (not sub-contracts).

E X A M P L E :

The Company uses contract labor for engineering related services,and bills this labor as if it were for regular employees. The Companyprovides office space, administrative support, and controls thecontract laborers. Therefore, contract laborers are consideredemployees, and their labor costs ($52,000 for the period audited) havebeen included in the direct labor base.

3. FACILITIES CAPITAL COST OF MONEY (FCCM)

Provide the cost-of-money rate, as calculated in accordance with FAR§31.205-10.

E X A M P L E :

The cost-of-money rate has been calculated in accordance with FAR§31.205-10, using average net book values of equipment and facilitiesmultiplied by the average treasury rate for the applicable period.Equipment and facilities include furniture and fixtures, computerequipment, vehicles, and leasehold improvements. The calculationwas made as follows:

12/31/xx

Net Book Value of Corporate Assets $267,520

Average Treasury Rate 5%

Computed Facilities Capital $ 13,376

Direct Labor Base $1,042,535

Cost-of-Money Rate 1.28%

Uniform Audit & Accounting Guide For Transportation Consultants December 2001 1/3/2002

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4. DEPRECIATION

E X A M P L E :

The depreciation reflected on the Company’s financial statements differs from that used and acceptable for federal income tax purposes. Since the financial statement amounts are lower than the amounts used for federal purposes, the amounts included in the Schedule of Indirect Cost Pools are allowable under FAR §31.205-11(e).

5. RELATED PARTY TRANSACTIONS Identify any related parties, to the extent that audit adjustments are required, and the amounts of required FARs adjustments [per §31.205-26(e) and §31.205-36(b)(3)].

E X A M P L E :

The Company rents one of its two offices from a shareholder. The actual occupancy costs include interest expense of $140,500. The Facilities Capital Cost of Money for the shareholder totals $118,939, resulting in an unallowable amount of $21,561. The rent expense recorded in the Company’s financial statements exceeds the owner’s actual occupancy costs by $18,000 (unallowable). Consequently, rental expense has been adjusted downward by $118,939 to reflect the provisions of FARs §31.205-36(b)(3).

The officers of the Company have personal usage of Company vehicles. Amounts attributable to this personal use ($X,XXX for 20xx) were disallowed.

6. AUDITOR CONTACT The auditor’s name, address, phone/fax numbers, and e-mail address are required.

E X A M P L E :

AUDITOR CONTACT

The person(s) to contact relative to this engagement is (are): John Doe, CPA

C/O Department of Transportation

000 First St.

Denver, Co 80256

Phone: (xxx) 555-1212

Fax: (xxx) 555-1234 E-mail: [email protected]


10—110—1

Chapter Ten - Cognizant AuditsNHS Act - Section 307In 1995, Congress passed the latest version of the National Highway SystemDesignation Act (For detailed information, see the following site:www.fhwa.dot.gov/infrastructure/progadmin/consultant.) This legislation,which was subsequently signed into law, had a profound impact on how somestates paid consulting engineers for the overhead portion of their costs on federallyparticipating contracts. Heretofore, approximately half the states had self-imposedceilings on overhead limits and/or maximum hourly rates associated with indirectlabor. Section 307 of the NHS Act prohibited the use of such limitations onfederally participating contracts. The NHS Act, however, did provide a one-yearwindow for states to adopt statutes that would establish “an alternative processintended to promote engineering and design quality and ensure maximumcompetition.” If a statute were adopted by a state within this period, Section 307would not bind the state. Thirteen states adopted such statutes within the allowedtime period. Such states are referred to as “opt out states.” They are:CT,DE,FL,KY,LA,ME,MD,MN,NY,NC,UT,TN,WV.

Section 307 also strived to establish an audit environment that was uniform amongthe states and not duplicative. Uniformity was to be achieved by requiring states orother audit entities to use the cost principles found in the Federal AcquisitionRegulations (Part 31 of Title 48, Code of Federal Regulations) when performingcost audits of consulting engineering firms. Though mandated in Section 307, thestates had previously used the Federal Acquisition Regulations to determineeligibility of indirect costs on engineering contracts.

The avoidance of duplicate audits was addressed in Section 307 through theintroduction of the term “cognizancy.” This term laid the groundwork for statesand other audit entities to have to use the work of others if an audit had beenpreviously performed by a “cognizant agency.” Unfortunately, Section 307 did notprovide a definition for cognizant agency. In order to develop an acceptabledefinition of cognizant agency and cognizant audit, the American Association ofState Highway and Transportation Officials (AASHTO) Audit Subcommittee andthe American Council of Engineering Companies (ACEC) TransportationCommittee joined forces to develop acceptable definitions of these terms that

Chapter

10


10—210—2

could be used by the Federal Highway Administration when adopting rules for theimplementation of Section 307.

The AASHTO Audit Subcommittee and the ACEC Transportation Committeeunanimously adopted the following definitions for these terms during their meetingsconducted during the late summer of 2000.

A “Cognizant Agency” is any one of the following:

• Federal Agency

• The Home State Transportation or Highway Department (i.e.,state where the firm’s accounting and financial records arelocated)

• A Non-Home State Transportation or Highway Department towhom the Home State has transferred cognizance in writing forthe particular indirect cost audit of a firm.

A “Cognizant Audit” is achieved by any one of the following methods:

• A Cognizant Agency performs or directs the work of a CPA whoperforms the indirect cost audit.

• Non-Home State auditor or CPAs working under this State’sdirection issue an audit report and the Home State issues a letterof concurrence. If the Home State does not accept the audit ofanother State, the Home State will have 180 days from receiptto issue a cognizant audit; otherwise, the Non-Home State auditreport will be cognizant for the 1 year applicable accountingperiod.

• An indirect cost audit performed by a CPA hired by the firm willbecome a cognizant audit if one of the following conditions ismet:

(a) The Home State reviews the CPA’s working papers andthe Home State issues a letter of concurrence with theaudit report.

(b) A Non-Home State reviews the CPA’s working papersand issues a letter of concurrence with the CPA report,which is then accepted by the Home State. If the HomeState does not accept the Non-Home State’s review, theHome State will have 180 days from receipt to completea review of the CPA audit report and either concur withit, modify it, or reject it due to a material error requiringre-submittal; otherwise, the CPA audit report with which


10—310—3

the Non-Home State has concurred will be cognizant forthe 1 year applicable accounting period.

In addition to the above definitions, the AASHTO Audit Subcommittee adoptedguidelines to be used in reviewing indirect costs audits performed by publicaccounting firms and issuing letters of concurrence. The guidelines can be found inthe next section of this chapter.

In conclusion, Section 307 of the NHS Act did not make changes in how indirectcosts audits should be performed by audit entities. The focus of Section 307 wasto remove the ceilings on overhead rates and indirect salaries that had beenestablished by some states, avoid duplicate indirect cost audits of the same firm bymultiple audit entities, and reinforce the need for all audit entities to use theFederal Acquisition Regulations for the purpose of determining cost eligibility.

Guidelines for Reviewing CPA Indirect Cost AuditsThe following minimum guidelines should be followed when a statetransportation/highway department audit organization reviews a CPA indirect costaudit report and issues a letter of concurrence for purposes of establishing acognizant audit as referenced in 23 CFR Part 172.

• The reviewing state should obtain documentation that evidences the CPA’saccomplishment of the continuing education requirements identified inparagraphs 3.6 and 3.7 and the external quality control review requirementsfound in paragraph 3.33 of the Governmental Auditing Standards (YellowBook).

• The reviewing state should determine that the CPA’s audit report format is inmaterial compliance with the “Uniform Indirect Cost Rate Audit Report FormatFor Engineering Consulting Firms” prepared and adopted by the AASHTOAudit Subcommittee and the ACEC Transportation Committee.

• The reviewing state should determine that the CPA audit was conducted inaccordance with the Field Work Standards for Financial Audits found inchapter four of the Governmental Auditing Standards and the FederalAcquisition Regulations.

The following steps should be performed to make these determinations:

1. Review the CPA’s working papers.

2. Request any additional supplemental tests the reviewing state deemsnecessary.


10—410—4

The reviewing state upon satisfactory completion of this review shall issue a letterof concurrence with the CPA’s indirect cost audit report of the firm. The stateauditor and audit manager who performed and supervised the review shall sign theletter. Documentation to support this review shall be retained by the reviewingstate for a minimum of three years from the date of the letter of concurrence. Theletter of concurrence shall be addressed to the audited firm.

Uniform Audit & Accounting GuideFor Transportation ConsultantsDecember 2001

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Appendix A - State Cost PrinciplesThis section provides key contact audit personnel from the respective states. Individualsshould be contacted for specific detailed limits and/or guidelines. Contact information isalso available in the AASHTO, Administrative Subcommittee on Internal and ExternalAudit, Membership Directory (August 2000).

State Audit Contact Person Phone NumberAlabama C. Lamar McDavid 334-242-6359Alaska Robert W. Janes 907-465-2080Arizona Michael Schwartz 602-712-7334Arkansas Leonard E. Grinstead 501-569-2516California Gerald Long 916-323-7122Colorado Casey Tighe 303-757-9661Connecticut William P. Scholl 860-594-2181Delaware Robert Uhle 302-760-2055Florida Cecil T. Bragg 850-488-2501Georgia Jerry M. Satterfield 404-656-5247Hawaii Bert Nishimura 808-587-2133Idaho Carolyn A. Rosti 208-334-8834Illinois David G. Campbell 217-782-7427Indiana Tom Becher 317-232-531Iowa Tom Devine 515-239-1625Kansas Dale Jost 785-296-3545Kentucky Mike Coffey 502-564-6830Louisiana J. Preston Perilloux 225-237-1313Maine Richard Alessandro 207-287-2902Maryland Romi Shah 410-545-8702Massachusetts Michael J. Byrne 617-973-7411Michigan Jerry J. Jones 517-373-2384Minnesota Ronald W. Gipp 651-296-3254Mississippi P. Diane Gavin 601-359-7500Missouri Donna Ruder 573-526-1244Montana J. Dennis Sheehy 406-444-6343Nebraska Jim Dietsch 402-479-4558Nevada Bob Dimmick 775-888-7007New Hampshire Douglas S. Rowden 603-271-1557New Jersey Timothy Maloney 609-530-2343New Mexico Mike R. Miera 505-827-3751New York Thomas J. Goodfellow 518-457-3180

AppendixA


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North Carolina Todd Jones 919-733-3624North Dakota Roberta L. Keller 701-328-2486Ohio Sam Kelley 614-644-6395Oklahoma John K. Parker 405-521-2511Oregon Dan Motley 503-986-3957Pennsylvania John Yodock 717-787-7003Rhode Island James R. Choquette 401-277-2297South Carolina Glynis Davis 803-737-1604South Dakota Tim P Flannery 605-773-3591Tennessee Julia Burton 615-253-4272Texas Dalton Ritter 512-463-8638Utah Stephen C. Reitz 801-965-4633Vermont Michael R. Pollica 802-828-3598Virginia Judson D. Brown 804-225-3597Washington State Wayne Donaldson 360-705-7004West Virginia Albert O. Adams 304-558-3101Wisconsin Dennis Schultz 608-266-3799Wyoming Jennifer Jessen 307-777-4391Puerto Rico Juan E. Encarnacion

Medina809-729-1530

AASHTO Liaison Roger Roberts 202-624-5803FHWA Liaison John Jeffers 404-562-3578

Uniform Audit Guide – AASHTO Regional Representatives

Region Name HomeState

Phone NumberEmail

States Represented

Northeastern States(NAASHTO)

William Scholl

and

Mike Pollica

CT

VT

860-594 [email protected]

[email protected]

Connecticut, Delaware, Maine,Maryland, Massachusetts, NewHampshire, New Jersey, New York,Pennsylvania, Rhode Island,Vermont, District of Columbia,Puerto Rico

Southeastern States(SAASHTO)

John Greene Fl 850-488-2501 ext [email protected]

Alabama, Arkansas, Florida, Georgia,Kentucky, Louisiana, Mississippi,North Carolina, South Carolina,Tennessee, Virginia, West Virginia

Midwestern States(Mississippi Valley)

Jerry Koerner

and

Bruce Kalland

WI

MN

[email protected]

[email protected]

Illinois, Indiana, Iowa, Kansas,Michigan, Minnesota, Missouri,Nebraska, Ohio, Wisconsin

Western States(WAASHTO)

MickeySchwartz

AZ [email protected]

Alaska, Arizona, California,Colorado, Hawaii, Idaho, Montana,Nevada, New Mexico, North Dakota,Oklahoma, Oregon, South Dakota,Texas, Utah, Washington, Wyoming


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Acknowledgements:Many people have contributed to this guide over the last few years. Their knowledge, timeand travel money is greatly appreciated and represents a nationwide team effort. Some ofthe more significant contributors are listed below.

Individual StatesAlabama C. Lamar McDavidArizona Michael SchwartzFlorida John GreeneIllinois David Campbell & Carl D. RichardsIowa Tom Devine & Matt SwansonMinnesota Lee AndersonMissouri Donna RuderNebraska Dave VondraNew York Thomas J. GoodfellowNorth Carolina Todd JonesPennsylvania John YodockSouth Dakota Mary JohnstonTennessee Julia BurtonWisconsin Randy Knoche & Jerry Koerner

FHWA Southern Resource CenterJohn Jeffers & Michael Thomas

ACECJim Anderson & Betsy Scott, HNTBJennifer Foutts, Otak, Inc.Tim Stowe, Anderson & AssociatesRay Williams, Ralph Whithead Associates, Inc.Mark Wilson, Kimley-Horn & Associates


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Appendix B Glossary of TermsThe following terms are used throughout this guide:

Actual Cost AgreementThe term Actual Cost Agreement does not mean that a consultant will be reimbursed for all actual costsincurred for performing a job. Costs are reimbursed subject to the limitations described in the agreement,contract, or specified criteria. These limitations can be very restrictive. An example is interest on borrowedmoney. This is a cost of doing business, yet it is not reimbursable as an actual cost of doing business.Actual CostsAmounts determined on the basis of costs incurred and supported by original source documentation, ascompared to forecasted costs, or costs thought to have been incurred, or costs based on historical averages.Advance AgreementAn understanding included in an agreement by the contracting officer and the consultant as to thetreatment of special or unusual costs not already included in FARs. The agreement must be in writing,executed by both the contracting parties, and incorporated into applicable current and future contracts. Anadvance agreement shall contain a statement of its applicability and duration. See 48 CFR 31.109.AgreementA contract. A binding, legal, document which identifies the deliverable goods and services being provided,under what conditions, and the method of payment for such services. The document may include federalcriteria and state requirements which will have to be adhered to by the state and the consultant. Thedocument will usually indicate start and finish dates, record retention requirements, and other pertinentinformation relative to the actual work to be performed.All-Inclusive Hourly Rate AgreementAn agreement using an hourly rate developed for billing purposes which may include a firm’s actual directlabor cost, overhead rate allowed or negotiated, and negotiated profit margin. Provisional hourly ratesgenerally are temporary and will be adjusted by an audit. Negotiated hourly rates may be used for the lifeof an agreement, or may be adjusted from time to time depending on the agreement provisions.

AllocableA cost is allocable (to an agreement or cost of work being performed for the government) if it benefits boththe agreement and other work of the firm and the cost can be distributed in reasonable proportion to thebenefits of incurring that cost.Allowable (Cost)An item of cost that can be billed directly as a project cost or indirectly as an overhead cost by theconsultant.Audit CycleThe series of steps auditors go through in completing their assigned work. The process includes a review ofa firm’s permanent file maintained by the Audit Office, preliminary audit work including scheduling ofbilled costs, arranging an appointment to conduct the audit, entrance conference, field work, review of a

Appendix

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firm’s documentation, exit conference, report write up, submittal of draft report to auditee for comment,and issuance of the final report.Audit Resolution ProcessThe process that SHA management and the auditee go through in resolving audit findings. It may involvenegotiation of a settlement, legal counsel, and court procedures.Audit TrailThe auditable record left by a transaction in a firm’s accounting records from original source documentinto subsidiary ledgers through the general ledger and into financial statements and invoices.Billing RateThe billing rate generally refers to the hourly labor rate being charged for work on an agreement. For a costplus fixed fee agreement, the billing rate will be the employee’s actual payroll rate. For an all-inclusivehourly rate agreement, the billing labor rate will include the actual payroll rate plus an overhead percentageplus an amount for fee.Cognizant AuditThis concept was developed to assign primary responsibility for the audit to one organization and to avoidduplication of audit work when auditing the indirect cost schedule. The audit work may be done by thehome state auditors, a Federal audit agency, a CPA firm, or a non-home state auditor designated by thehome state auditor.Common ControlExists in related party transactions when business is conducted at less than arm’s length betweenbusinesses and/or persons that have a family or business relationship. Examples are transactions betweenfamily members, transactions between subsidiaries of the same parent company, or transactions betweencompanies owned by the same person or persons.Contracting OfficerA title sometimes used in private and public sectors to indicate the person having authority to enter into acontract or agreement for goods and services.CorporationA business structure where stock is made available for purchase. The firm may have a president, vicepresident, treasurer, and secretary. Anyone working for the corporation is usually paid an hourly wage rateor is salaried. In theory, the liabilities of the individual stock owners are limited in this type of businessstructure.

Cost Accounting StandardsCost Accounting Standards (CAS) are the rules, regulations and standards, which are promulgated by theCost Accounting Standards Board (CASB). The CASB is located within the Office of Federal ProcurementPolicy, which is under the direction of the Office of Management and Budget (OMB) of the Federalgovernment.Cost CenterCost centers are used to accumulate and segregate costs.Cost ObjectiveAn agreement, contract, function or organizational subdivision for which cost data are desired and forwhich provision is made to accumulate and measure the cost of processes, products, jobs, capitalizedprojects, etc.Cost of MoneyFacilities capital cost of money in an imputed cost determined by applying a cost-of-money rate tofacilities capital employed in contract performance.Cost Plus Fixed Fee AgreementAn agreement in which all the cost factors except fee are actual cost. The fixed fee is a set dollar amount inthe agreement.Cost PrinciplesThe underlying basis for determining how costs should be recorded when they are allowable orunallowable, and the specific basis for treating various costs as either allowable or unallowable.Courtesy Audit


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An audit performed for another state, another state agency, or city or county government. The audit couldbe a preaward, interim or post, with the requesting agency paying for the cost of the audit.Direct CostAny cost that can be identified specifically with a particular final cost objective, i.e., a project related cost.Direct costs would include labor, materials, and reimbursables incurred specifically for an agreement. It isirrelevant whether or not the costs are actually billed. All direct labor costs must be included in the directlabor base. All costs for lump sum agreements must be included in direct costs.Entrance ConferenceA meeting between the auditor and the auditee, at which time the purpose and scope of the audit arediscussed.Exit ConferenceA meeting held after the auditor completes field work at the auditee’s place of business. Topics ofdiscussion are preliminary findings of the audit, which are subject to change and revision during thesupervisory workpaper review process, and/or a formal request for the auditee’s response to the draftaudit report.Federal Acquisition Regulations (FARs) Code of Federal Regulations No. 48Sets the criteria for allowable and unallowable costs for federally funded agreements. The FARs are alsoused as a guideline for other government contracting such as State contracts. Part 31.2 is the primarysection pertaining to State Highway Agencies.FindingA statement of noncompliance with the terms of an agreement. A finding includes the condition, criteria,cause, effect, and a recommendation for correction.General and Administrative ExpensesAny management, financial, and other expense which is incurred by or allocated to a business unit, andwhich is for the general management and administration of the business as a whole.Generally Accepted Auditing Standards (GAAS)These are standards for financial statement audits set forth by the American Institute of Certified PublicAccountants. The standards pertain to auditors’ professional qualifications, the quality of audit effort,and the characteristics of professional and meaningful audit reports.Generally Accepted Governmental Auditing Standards (GAGAS)These are standards for audits of government organizations, programs, activities, and functions, and ofgovernment assistance received by contractors, nonprofit organizations, and other non-governmentorganizations. These standards also incorporate GAAS for financial-related audits.Indirect CostAny cost not directly identified with a single, final cost objective, but identified with two or more final costobjectives or an intermediate cost objective. Consultants recover their indirect costs in their overhead rate.Interim AuditAn audit, which may be of limited scope, during the life of an agreement. The purpose is to determine theactual allowable costs to date, review and adjust a firm’s overhead rate, and audit a prime consultant’ssubcontracts. This audit follows a standard audit plan.Internal ControlThe plan of organization and methods and procedures adopted by management to ensure that its goalsand objectives are met; that resources are used consistent with laws, regulations, and policies; thatresources are safeguarded against waste, loss, and misuse; and that reliable data are obtained,maintained, and fairly disclosed in reports.Lump Sum (Fixed Price) AgreementAn agreement where the method of payment for delivery of goods and services is one set amount thatincludes salaries, overhead, and profit with no adjustments. Once the lump sum amount is agreed upon,the services or goods must be provided regardless of the actual cost to the consultant.Negotiated Hourly Rate AgreementAn agreement in which hourly billing rates that include labor, overhead, and fee are negotiated in advanceand are listed for a 12-month period or more.Overhead Expenses


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All allowable general administrative expenses and fringe benefit costs (sometimes called payroll additives).Depending on the size of the firm, these costs may or may not be separately identified on a schedule ofoverhead costs.Overhead RateA computed rate usually developed by adding together all of a firm’s costs that cannot be associated witha single cost objective, including general and administrative costs, fringe benefit costs, then dividing by abase value, usually direct labor dollars, to get a percentage. This rate is applied to direct labor to allow afirm to recover the share of indirect costs allowable to the agreement.

Overtime CompensationCompensation paid to employees who work more then a certain amount of hours within a pay period,usually 40 hours. The pay rate may be based on the normal salary rate or may include “premiumovertime” such as time and a half, or double time. In most cases, premium overtime is required for hourlyworkers and is optional for certain salaried employees.PartnershipA business with two or more co-owners, who may or may not have established salaries. The liabilities ofthe firm are the owners’ responsibility. Owners may be treated the same as sole proprietors by the auditorsregarding the establishment of a salary rate.Post AuditAn audit done after the completion of all work by a consultant. Its scope may include all billed costs bythe prime consultant and/or any sub consultants providing services. This audit follows a standard auditplan.Preaward ReviewAn audit conducted on behalf of SHA management for the purpose of validating financial informationsupplied by a potential contractor. The audit may require an on site visit or information may be reviewedat the Audit Office. Upon completion, the information is provided to the SHA contracting officer in anaudit report for use during agreement negotiations. This audit follows a special pre-award audit plan.Provisional Hourly Rate AgreementAn agreement in which hourly billing rates that include labor, overhead, and fee are negotiated in advance,but are subject to adjustment after an audit determines actual labor and overhead rates.Reasonable CostA cost, if in its nature and amount, does not exceed that which would be incurred by a prudent person inthe conduct of competitive business.Record of NegotiationA summary memorandum prepared by the SHA contracting officer regarding the reconciliation betweenthe consultant’s proposal and the SHA estimate. It includes contract rate negotiations, disposition ofsignificant matters in the pre-award audit report, and reasons why audit recommendations were notfollowed. It is required by 48 CFR 42.706(b).Single AuditIn theory, an audit which satisfies the needs of all parties involved with funding or doing business with anorganization, either private or public.Sole ProprietorshipA business with one owner. From an audit standpoint, this person may not have an established salary, butinstead may rely on draws from the profits of the firm to obtain their payment for services.Source DocumentationOriginal documents, including but not limited to time sheets, invoices, hotel receipts, rental slips, gasolinetickets, canceled checks, tax returns, insurance policies, minutes of corporate meetings, etc., which supportthe costs recorded in the firm’s accounting ledgers and which may be used for billing purposes to thegovernment or for income tax purposes.

Task Assignment AgreementsAn agreement without a definite description of work, but with a specified time period. Tasks which requirethe consultant’s expertise are assigned as needed. Each task will have its own maximum payable amount.The total amount paid on all of the tasks cannot exceed the total amount of the agreement.


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Unallowable (Cost)An item of cost which cannot be billed directly or indirectly by a consultant. These types of costs, if foundduring an audit will be purged from the costs billed directly, or from those billed indirectly via an overheadrate or cost center. When an unallowable cost is incurred, its directly associated costs are also unallowable.


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Appendix C - Listing of Resource MaterialsThis section provides a listing of resource materials that are commonly used as guides byauditors in performing government contract audits. The listing is not all-inclusive butattempts to highlight the most frequently used materials. While paper copies are availablemost of the publications are now also available on CD ROM disks or via the Internet.These are especially useful because of the built-in search features that enable the users toquickly find specific information. The listing is presented in the order of most useful orrelevant first followed by publications that are least useful.

Government Auditing Standards (“Yellow Book”)Pub l i shed by : Un i ted S ta tes Gene ra l Accoun t ing O f f i ce(GAO) ,By the Compt ro l l e r Genera l( C u r r e n t v e r s i o n a v a i l a b l e a t : _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

P u r p o s e : ( q u o t e f r o m i n t r o d u c t i o n )“This document contains standards for audits of government organizations,programs, activities, and functions, and of government assistance received bycontractors, nonprofit organizations, and other nongovernmentalorganizations. These standards, often referred to as generally acceptedgovernment auditing standards (GAGAS), are to be followed by auditors andaudit organizations when required by law, regulation, agreement, contract, orpolicy. The standards pertain to auditors’ professional qualifications, thequality of audit effort, and the characteristics of professional and meaningfulaudit reports.”

Federal Acquisition Regulations (FARs)Pub l i shed jo in t l y by :United States Department of Defense (DOD), General ServicesAdministration (GSA) and National Aeronautics and Space Administration(NASA)

F o r m a t :Available in paper, CD ROM and on the Internet at www.arnet.gov/far.Another good source is at the Federal Government main home page which iswww.firstgov.gov, then search for “Federal Acquisition Regulations.”

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C o n t a i n e d i n :Code of Federal Regulations at 48 CFR Chapter 1

R e l e v a n t P a r t :Part 31 - Contract Cost Principles and Procedures

P u r p o s e :Provides primary authoritative guidelines for acquisition of supplies andservices by government agencies. Provides detailed explanations of specificrules for allowable and unallowable costs.

DCAA Contract Audit ManualPub l i shed by :United States Department of Defense, Contract Audit Agency (DCAA)

Formats :Two volume set of paper manuals published twice per year

Available on CD ROM called “Defense Acquisition Deskbook”

Available on the Internet at: http://www.deskbook.osd.mil orwww.dcaa.mil

P u r p o s e : ( q u o t e p e r m a n u a l )“It prescribes auditing policies and procedures and furnishes guidance inauditing techniques for personnel engaged in the performance of the DCAAmission.”

American Institute of Certified Public Accountants (AICPA)Pub l i shed by :The AICPA is the premier national professional association for CPAs in theUnited States. This organization produces numerous publications to assistaccountants and auditors in following accounting principles and auditingstandards.

Formats :1. AICPA materials are generally available in hard-copy form in a

variety of formats including Audit & Accounting Guides, AuditGuides, Professional Standards Binders, Statements of Position,Newsletters, Exposure Drafts and others.

2. All of the AICPAs professional literature is available on CD-ROMwith built in search capabilities.

3. Many of the materials are available on the Internet at the AICPAwebsite which is: http://www.aicpa.org


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Par t ia l L i s t ing o f He lp fu l Mater ia ls :1. AICPA Professional Standards (Two Volume Set)

2. Audits of Federal Government Contractors - Audit and AccountingGuide (1998)

3. Auditing Recipients of Federal Awards: Practical Guidance forApplying OMB Circular A-133, Audits of States, LocalGovernments and Non-Profit Organizations (1998)

4. Codification of Statements on Auditing Standards as of January 1,2000

5. Accounting Trends and Techniques -CD-ROM

6. Audit Sampling - Auditing Practice Release

7. Auditing in Common Computer Environments - Auditing PracticeRelease

Accounting Standards - Current TextPub l i shed by :Financial Accounting Standards Board

F o r m a t :Hard-copy 3 volume set

P u r p o s e :This guide is an integration of currently effective accounting and reportingstandards. Material is drawn from AICPA Accounting Research Bulletins,APB Opinions, FASB Statements of Financial Accounting Standards, andFASB Interpretations. While its focus is primarily publicly-tradedcorporations, some of the material may be helpful for government auditors.


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Appendix D - Listings, Tools and Examples

D-2. Listing of Common Unallowable Expenses

D-3. Example of Schedule of Indirect Costs (Home & FieldOffice Rates)

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Listing of Common Unallowable ExpensesThe following table provides a listing of expenses that are generally not allowed (underprovisions of the Federal Acquisition Regulations, part 31.2) by commercial enterprisesperforming contracts for the government. The list identifies transactions that arecommonly incurred by consulting engineering firms.

FARReference Unallowable Expenses

31.205-1 Advertising31.205-1 Trade Show Expenses31.205-1 Trade Show Labor31.205-1 Promotional Material/Brochures31.205-1 Souvenirs/Imprinted Clothing Provided to Public31.205-1 Membership in Civic and Community Organizations31.205-3 Bad Debts31.205-3 Collection Costs31.205-6 Personal Use of Company Vehicles31.205-8 Contributions or Donations31.205-13 Employee Gifts & Recreation31.205-14 Membership in Social/Dining/Country Clubs31.205-14 Social Activities31.205-15 Fines/Penalties31.205-19 Key-Man Life Insurance31.205-19 Re-Work Insurance31.205-20 Interest Expense31.205-22 Lobbying Costs31.205-27 Organization/Re-organization Legal Fees31.205-27 Organization/Re-organization Accounting Fees31.205-27 Organization/Re-organization Incorporation Fees31.205-27 Organization/Re-organization Labor31.205-27 Capital Raising (Equity or LT Debt) Legal Fees31.205-27 Capital Raising (Equity or LT Debt) Accounting Fees31.205-27 Capital Raising (Equity or LT Debt) Lender Fees31.205-30 Patent Costs31.205-33 Retainer agreements31.205-35 Relocation Costs (If Over $1,000)31.205-46 Travel Costs in Excess of FTR Rates31.205-49 Goodwill31.205-51 Alcoholic Beverages


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Schedule of Indirect CostsExample: (Showing Field Plus Home Office Rates)

DIRECT LABOR: Home Office 1,343,665Field Office 948,220

Total Direct 2,291,885$ Allocation

Proposed Allocable Expenses

Unallowable Expenses FAR Reference

Audited Expenses

Field Office Home Office

FRINGE BENEFITSInsurance - Group 111,354$ -$ 111,354$ 46,070$ 65,284$ Insurance - Life 4,197 (670) 31.205-19 3,527 1,459$ 2,068Payroll - Bonus 164,650 0 164,650 68,121$ 96,529Payroll - Holiday 83,722 0 83,722 34,638$ 49,084Payroll - Sick 22,343 0 22,343 9,244$ 13,099Payroll - Vacation 90,838 0 90,838 37,582$ 53,256Payroll - Taxes 240,003 0 240,003 99,296$ 140,707

Total Fringe Benefits 717,107$ (670)$ 716,437$ 296,411$ 420,026$

GENERAL OVERHEADIndirect Labor 621,191 0 621,191 257,005$ 364,186Accounting & Legal 9,357 0 9,357 1,224 8,133Advertising & Promotion 3,362 0 3,362 4 4 0 2,922Auto Expense 60,665 (3,413) 31.205-6 57,252 7,489 49,763Computer Service 6,288 0 6,288 8 2 2 5,466Continuing Education 7,407 (972) 31.205-44 6,435 8 4 2 5,593Convention & Seminars 5,144 0 5,144 6 7 3 4,471Depreciation & Amortization 138,625 0 138,625 18,132 120,493Dues, Memberships, Licenses 4,590 (320) 31.205-1 4,270 5 5 9 3,711Employee Welfare 11,197 0 11,197 1,465 9,732Equipment Rental 23,481 (1,622) 31.205-1 21,859 2,859 19,000Insurance - Auto & Trucks 29,683 (2,908) 31.205-6 26,775 3,502 23,273Insurance - General 204,035 (49,973) 31.205.19 154,062 20,151 133,911Insurance - Workers' Comp 17,584 (5,455) 31.205.19 12,129 1,586 10,543Miscellaneous Expenses 5,189 0 5,189 6 7 9 4,510Office Supplies & Expenses 79,429 0 79,429 10,389 69,040Postage & Delivery 15,557 0 15,557 2,035 13,522Professional Fees 32,259 0 32,259 4,220 28,039Rent - Building 100,173 0 100,173 13,103 87,070Repairs & Maintenance 42,831 0 42,831 5,602 37,229Subscriptions 6,178 0 6,178 8 0 8 5,370Survey Supplies 24,318 0 24,318 3,181 21,137Taxes 11,923 0 11,923 1,560 10,363Telephone 38,299 0 38,299 5,010 33,289Travel 15,476 (65) 31.205-46 15,411 2,016 13,395Utilities 20,732 0 20,732 2,712 18,020Gain on Sale of Assets (500) (500) (65) (435)Contributions 6 9 8 (698) 31.205-8 0 0 0Entertainment 9,851 (9,851) 31.205-14 0 0 0

Total General Overhead 1,545,022$ (75,277)$ 1,469,745$ 367,997$ 1,101,748$

Indirect Cost Overhead Rate 95.39% 70.07% 113.26%

Sample Engineering, Inc.Schedule of Indirect Costs & Rate Calculation

For the Year Ended December 31, 1999

Notes:(1) Indirect salaries were allocated to field office on the basis of direct labor.(2) Indirect expenses were allocated to field office based on a ratio of allocated indirect salaries to total home office salaries (Home Office Direct Labor plus Total Indirect Labor) resulting in 13.08 % to the field.Fringe Benefit Allocation: Field = 31.26% of Field DL Home = 31.26% of Home DL

General OH Allocation: Field = 38.82% of Field DL Home = 82.06% of Home DL

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